Exercise 11-7 Net Present Value Analysis and Simple Rate of Return [LO11-2, LO11
ID: 2404109 • Letter: E
Question
Exercise 11-7 Net Present Value Analysis and Simple Rate of Return [LO11-2, LO11-4]
Derrick Iverson is a divisional manager for Holston Company. His annual pay raises are largely determined by his division’s return on investment (ROI), which has been above 20% each of the last three years. Derrick 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. Holston Company’s discount rate is 18%. The project would provide net operating income each year for five years as follows:
Click here to view Exhibit 11B-1 and Exhibit 11B-2, to determine the appropriate discount factor(s) using tables.
Compute the project's net present value. (Use the appropriate table to determine the discount factor(s), intermediate calculations and final answer to the nearest dollar amount.)
Compute the project's simple rate of return. (Round your answer to 1 decimal place. i.e. 0.123 should be considered as 12.3%.)
Derrick Iverson is a divisional manager for Holston Company. His annual pay raises are largely determined by his division’s return on investment (ROI), which has been above 20% each of the last three years. Derrick 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. Holston Company’s discount rate is 18%. The project would provide net operating income each year for five years as follows:
Explanation / Answer
Calculation of Cash returns per year.
Sales
$ 3,600,000.00
Variable expenses
$ 1,550,000.00
Contribution margin
$ 2,050,000.00
Fixed expenses:
Advertising, salaries, and other fixed
$ 700,000.00
out-of-pocket costs
Depreciation
$ 700,000.00
Total fixed expenses
$ 1,400,000.00
Net operating income
$ 650,000.00
Add: (non Cash Expense) Depreciation
$ 700,000.00
Net Cash Return Per year
$ 1,350,000.00
Part 1
Year
Cash Inflow (Outflow)
Discount Factor at 18%
Discounted Cash Flows
0
$ (4,200,000.00)
1
$ (4,200,000.00)
1
$ 1,350,000.00
0.847458
$ 1,144,067.80
2
$ 1,350,000.00
0.718184
$ 969,548.98
3
$ 1,350,000.00
0.608631
$ 821,651.68
4
$ 1,350,000.00
0.515789
$ 696,314.98
5
$ 1,350,000.00
0.437109
$ 590,097.44
Net Present Value
$ 21,680.88
Part 2
Simple rate of return
Return per year*100
Initial Investment
1350000*100
4200000
32.1%
Part 3a
Yes.
The Present value of Investment is Positive and Return is more than 20% so company would want derrick to continue
Part 3b
Yes.
The Present value of Investment is Positive and Return is more than 20% so company would want derrick to continue
Calculation of Cash returns per year.
Sales
$ 3,600,000.00
Variable expenses
$ 1,550,000.00
Contribution margin
$ 2,050,000.00
Fixed expenses:
Advertising, salaries, and other fixed
$ 700,000.00
out-of-pocket costs
Depreciation
$ 700,000.00
Total fixed expenses
$ 1,400,000.00
Net operating income
$ 650,000.00
Add: (non Cash Expense) Depreciation
$ 700,000.00
Net Cash Return Per year
$ 1,350,000.00
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