Casey Nelson is a divisional manager for Pigeon Company. His annual pay raises are largely determined by his division’s return on investment (ROI), which has been above 24% each of the last three years. Casey is considering a capital budgeting project that would require a $4,200,000 investment in equipment with a useful life of five years and no salvage value. Pigeon Company’s discount rate is 20%. The project would provide net operating income each year for five years as follows:
Sales $4,100,000
Variable expenses 1,880,000
Contribution margin 2,220,000
Fixed expenses:
Advertising, salaries, and other fixed out-of-pocket costs $770,000
Depreciation 840,000
Total fixed expenses 1,610,000
Net operating income $610,000
Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using tables.
Required:
1. What is the project’s net present value?
2. What is the project’s internal rate of return to the nearest whole percent?
3. What is the project’s simple rate of return?
4- a. Would the company want Casey to pursue this investment opportunity?
4- b. Would Casey be inclined to pursue this investment opportunity?