Question

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 20% each of the last three years. casey is considering a capital budgeting project that would require a $3,500,000 investment in equipment with a useful life of five years and no salvage value. pigeon company's discount rate is 16%. all sales are collected in cash, all variable expenses are paid in cash during the year they are incurred, and all out-of-pocket fixed expenses are paid in cash during the year they are incurred. the project would provide net operating income each year for five years as follows:

Answer 1

a. Compute the project's net present value.

• NPV = -$553,135.71

b. Compute the project's internal rate of return.

• 9.01%

Step-by-step explanation:

we need to calculate the net cash flows = net operating income + depreciation expense = $300,000 + $600,000 = $900,000

now we need to determine the net present value (NPV):

• initial investment -$3,500,000
• CF1 $900,000
• CF2 $900,000
• CF3 $900,000
• CF4 $900,000
• CF5 $900,000

Using an excel spreadsheet and the NPV function with 16% discount rate:

NPV = discounted cash flows - initial investment = $2,946,864.29

- $3,500,000 = -$553,135.71

We can also calculate the internal rate of return using excel and the IRR function:

IRR = 9.01%