Derrick Iverson is a divisional manager for Holston Company. Hisannual pay raises are largely determined by his division’s returnon investment (ROI), which has been above 20% each of the lastthree years. Derrick is considering a capital budgeting projectthat would require a $3,200,000 investment in equipment with auseful life of five years and no salvage value. Holston Company’sdiscount rate is 18%. The project would provide net operatingincome each year for five years as follows:
| | | | |
| Sales | | | $ | 2,800,000 |
| Variable expenses | | | | 1,150,000 |
| Contribution margin | | | | 1,650,000 |
| Fixed expenses: | | | | |
Advertising, salaries, and other fixed
out-of-pocket costs | $ | 610,000 | | |
| Depreciation | | 640,000 | | |
| Total fixed expenses | | | | 1,250,000 |
| Net operating income | | | $ | 400,000 |
|
Click here to view Exhibit 12B-1 and Exhibit 12B-2, to determinethe appropriate discount factor(s) using tables.
Required:
1. Compute the project's net present value.
2. Compute the project's simple rate of return.
3a. Would the company want Derrick to pursue this investmentopportunity?
3b. Would Derrick be inclined to pursue this investmentopportunity?
