Cardinal Company is considering a project that would require a $2,745,000 invest
ID: 2466036 • Letter: C
Question
Cardinal Company is considering a project that would require a $2,745,000 investment in equipment with a useful life of five years. At the end of five years, the project would terminate and the equipment would be sold for its salvage value of $500,000. The company’s discount rate is 18%. The project would provide net operating income each year as follows:
Sales $ 2,857,000
Variable expenses 1,011,000
Contribution margin 1,846,000
Fixed expenses:
Advertising, salaries, and other
fixed out-of-pocket costs $ 799,000
Depreciation 449,000
Total fixed expenses 1,248,000
Net operating income $ 598,000
What is the project profitability index for this project?
Explanation / Answer
Operating cash flow =Net operating income +depreciation
598000 + 449000
= 1047000
Present value of cash inflow = (PVAF@18%,5*OCF)+(PVF@18%,5* Salvage)
= (3.12717 * 1047000) + (.43711 * 500000)
= 3274148.06+ 218555
= $ 3,492,703.06
Profitability index =Present value /Initial investment
= 3,492,703.06 / 2,745,000
= 1.27
2)Simple rate of return = Net income /Initial investment
= 598000 / 2745000
= 21.79%