Cardinal Company is considering a project that would require a $2,792,000 invest
ID: 2472195 • 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:
551,600
What is the project’s net present value?
What is the project profitability index for this project?
What is the project’s payback period?
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
Net annual operating income = $551600
Net annual cash flow
= Net operating income + depreciation
= $551600 + $478400
=$1030000
NPV
= PV of annual cash inflow + PV of salvage value – initial investment
= $1030000 x PVIFA (14%,5) + $400000 x PVIF (14%,5) - $2792000
= $1030000 x 3.433 + $400000 x 0.519 - $2792000
=$951590
Profitability Index
= 1 + NPV/Initial investment
= 1 + $951590 / $2792000
= 1 + 0.34
= 1.34
Payback period = Initial investment / annual cash inflow = $2792000 / $1030000 = 2.71 years
Simple rate of return
= Incremental net operating income / (Initial investment-Salvage value)
= $551600 / $(2792000 – 400000)
= 23.06%