Derrick Iverson is a divisional manager for Holston Company. His annual pay raises are largely determined by his divisions 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 $3,200,000 investment in equipment with a useful life of five years and no salvage value. Holston Companys discount rate is 18%. The project would provide net operating income each year for five years as follows:
| Sales |
$ 2,800,000 |
| Variable expenses |
$ 1,150,000 |
|
|
| Contribution margin |
$ 1,650,000 |
| Fixed expenses: |
|
| Advertising, salaries, and other |
$ 610,000 |
| fixed out-of-pocket costs |
|
| Depreciation |
$ 610,000 |
|
|
| Total fixed expenses |
$ 1,220,000 |
|
|
| Net operating income |
$ 430,000
|
1. Compute the project's net present value.
2. Compute the project's simple rate of return.