Cardinal Company is considering a five-year project that would require a $2,860,
ID: 2394099 • Letter: C
Question
Cardinal Company is considering a five-year project that would require a $2,860,000 investment in equipment with a useful life of five years and no salvage value. The company’s discount rate is 14%. The project would provide net operating income in each of five years as follows:
13. Assume a postaudit showed that all estimates (including total sales) were exactly correct except for the variable expense ratio, which actually turned out to be 50%. What was the project’s actual net present value?
14. Assume a postaudit showed that all estimates (including total sales) were exactly correct except for the variable expense ratio, which actually turned out to be 50%. What was the project’s actual payback period?
15. Assume a postaudit showed that all estimates (including total sales) were exactly correct except for the variable expense ratio, which actually turned out to be 50%. What was the project’s actual simple rate of return?
Explanation / Answer
Solution 13:
Variable expense ratio = 50%
Actual variable Expense = Sales *50% = $2,859,000 *50% = $1,429,500
Annual cash inflows = Sales - variable expenses - Fixed out of pocket expenses = $2859000 - $1429500 - $700000 = $729,500
Present value of cash Inflows = Annual Cash Inflows * Cumulative PV factor for 5 years @14% = $729500*3.43308 =$2,504,432.57 (rounded to 2 decimal places)
Net Present value = Present value of cash Inflows - initial investment = $2,504,432.57 - $2,860,000
= - $355,567.43
Solution 2:
Annual cash Inflows = $729,500
Initial investment = $2,860,000
Payback period = Inital Investment / Annual cash Inflows = $2860000 / $729500 = 3.92 years
Solution 3:
Simple rate of return = Annual net operating income form project / Initial Investment
Actual Annual Net operting income = $487,000 - (increase in actual variable expenses) = $487000 - ($1429500 - $1100000) = $157500
Simple rate of return = $157500 / $2860000 = 5.507% (rounded)