Cardinal Company is considering a project that would require a $2,975,000 invest

Question

Cardinal Company is considering a project that would require a $2,975,000 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 $300,000. The company's discount rate is 14%. The project would provide net operating income each year as follows: Sales Variable expenses $2,735,000 1,000,000 1,735,000 Contribution margin Fixed expenses: Advertising, salaries, and other fixed out-of-pocket costs Depreciation $735,000 535,000 Total fixed expenses 1,270,000 Net operating income $ 465,000

Explanation / Answer

Cash inflow = $465000 + $535000

= $1000000

Net Present value:

Year Cash flows Discount rate 14% PV of cash flows

1 to 5 $1000000 3.4331 $3433100

5 $300000 0.5194 $155820

Total PV of cash flows $3588920

Initial investment ($2975000)

NPV $613920

Profitability index = $3588920 / $2975000

= 1.21 .

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