Cardinal Company is considering a project that would require a $2,792,000 invest
ID: 2469718 • Letter: C
Question
Cardinal Company is considering a project that would require a $2,792,000 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 $400,000. The company’s discount rate is 14%. The project would provide net operating income each year as follows:
Click here to view Exhibit 11B-1 and Exhibit 11B-2, to determine the appropriate discount factor(s) using tables.
What is the project profitability index for this project
What is the project’s net present value
Cardinal Company is considering a project that would require a $2,792,000 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 $400,000. The company’s discount rate is 14%. The project would provide net operating income each year as follows:
Explanation / Answer
Solution:
5) Calculation of Net Present Value of the Project
Year
Cash Flow
PV factor @ 14%
Present Value
0
($2,792,000)
1.000
($2,792,000)
1
1030000
0.877
$903,509
2
1030000
0.769
$792,552
3
1030000
0.675
$695,221
4
1030000
0.592
$609,843
5
1030000
0.519
$534,950
5
$400,000
0.519
$207,747
Net Present Value
$951,821
6) Profitability Index = Present Value of Cash Flow / Present Value of Cash Outflow
Present Value of Cash Flow
Year
Cash Flow
PV factor @ 14%
Present Value
1
$1,030,000
0.877
$903,509
2
$1,030,000
0.769
$792,552
3
$1,030,000
0.675
$695,221
4
$1,030,000
0.592
$609,843
5
$1,030,000
0.519
$534,950
5
$400,000
0.519
$207,747
Present Value of Cash Flow
$3,743,821
Present Value of Cash Outflow = $2,792,000
Profitability Index = $3,743,821 / $2,792,000 = 1.34
5) Calculation of Net Present Value of the Project
Year
Cash Flow
PV factor @ 14%
Present Value
0
($2,792,000)
1.000
($2,792,000)
1
1030000
0.877
$903,509
2
1030000
0.769
$792,552
3
1030000
0.675
$695,221
4
1030000
0.592
$609,843
5
1030000
0.519
$534,950
5
$400,000
0.519
$207,747
Net Present Value
$951,821