MGAB03H3 Lecture Notes - Lecture 13: Discounted Cash Flow, Capital Budgeting, Product Defect
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A project that costs $2,700 to install will provide annual cash flows of $770 for each of the next 6 years. |
a. | Calculate the NPV if the opportunity cost of capital is 11%? (Do not round intermediate calculations. Round your answer to 2 decimal places.) |
NPV | $ |
b. | Is this project worth pursuing? | ||||
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c. | What is the project's internal rate of return IRR? (Do not round intermediate calculations. Round your answer to 2 decimal places.) |
IRR | % |
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 25% each of the lastthree years. Derrick is considering a capital budgeting projectthat would require a $5,160,000 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 | $ | 4,400,000 | |
Variableexpenses | 1,950,000 | ||
Contribution margin | 2,450,000 | ||
Fixedexpenses: | |||
Advertising, salaries, and other fixed out-of-pocketcosts | $790,000 | ||
Depreciation | 790,000 | ||
Total fixedexpenses | 1,580,000 | ||
Netoperating income | $ | 870,000 | |
Required: |
1. | Compute the project's net present value. (Round discountfactor(s) to 3 decimal places, intermediate calculations and finalanswer to the nearest dollar amount.) Net Present value: |
2. | Compute the project's simple rate of return. (Round youranswer to 1 decimal place. i.e. 0.123 should be considered as12.3%.) Simple rate of return%: |
3-a. | Would the company wantDerrick to pursue this investment opportunity? | ||||
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3-b. | Would Derrick beinclined to pursue this investment opportunity? | ||||
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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 $3,000,000 investment in equipment with auseful life of five years and no salvage value. Holston Company’sdiscount rate is 15%. The project would provide net operatingincome each year for five years as follows: |
Sales | $ | 2,500,000 | |
Variableexpenses | 1,000,000 | ||
Contribution margin | 1,500,000 | ||
Fixedexpenses: | |||
Advertising, salaries, and other fixed out-of-pocketcosts | $600,000 | ||
Depreciation | 600,000 | ||
Total fixedexpenses | 1,200,000 | ||
Netoperating income | $ | 300,000 | |
Click here to view Exhibit 13B-1and Exhibit 13B-2, to determine the appropriate discount factor(s)using tables. |
Required: |
1. | Compute the project'snet present value. (Round discount factor(s) to 3 decimalplaces.) |
2. | Compute the project's simple rate of return. (Round youranswer to whole decimal place i.e. 0.123 should be considered as12%) |
3-a. | Would the company wantDerrick to pursue this investment opportunity? | ||||
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3-b. | Would Derrick beinclined to pursue this investment opportunity? | ||||
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