Question

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 25% each of the last three years. Derrick is considering a capital budgeting project that would require a $5,160,000 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:

Sales $4,300,000 Variable expenses 1,900,000 Contribution margin 2,400,000 Fixed expenses: Advertising, salaries, and other fixed out-of-pocket costs$765,000 Depreciation765,000 Total fixed expenses 1,530,000 Net operating income $870,000 Compute the project's net present value.

Answer 1

NPV = (47,075.38)

Step-by-step explanation:

Net Present value(NPV) is method of evaluating investment proposal that considers the time value. To compute the NPV we do as follows:

NPV = Present Value of Cash inflow - Initial cost

Cash inflow is computed as follows:

Sales revenue - Variable cost - out of pocket fixed cost

Note that depreciation is not an item of cash out flow, so we do not include it in the calculation,

Annual cash inflow=

4,3000,000-1,900,000-765,000

= 1,635,000.

PV of cash inflow

= A × (1-(1+r)^(-n))/r

= 1,635,000 × (1-(1.18)^(-5))/0.18

= 1,635,000 × 3.127171021

= 5,112,924.62

NPV = 5,112,924.62 - 5,160,000

NPV = (47,075.38)