Question

Cardinal Company is considering a five-year project that would require a $2,915,000 investment in equipment with a useful life of five years and no salvage value. The company’s discount rate is 16%. The project would provide net operating income in each of five years as follows:

Sales | $ | 2,863,000 | ||

Variable expenses | 1,014,000 | |||

Contribution margin | 1,849,000 | |||

Fixed expenses: | ||||

Advertising, salaries, and other fixed out-of-pocket costs | $ | 781,000 | ||

Depreciation | 583,000 | |||

Total fixed expenses | 1,364,000 | |||

Net operating income | $ | 485,000 | ||

Click here to view Exhibit 12B-1 and Exhibit 12B-2, to determine the appropriate discount factor(s) using table.

rev: 05_11_2019_QC_CS-168512

5. What is the project profitability index for this project?

Answer #1

**The Project profitability index for this
project**

Annual cash flow = Net operating income + Depreciation expenses

= $485,000 + $583,000

= $1,068,000

Present Value of annual cash inflows = Annual cash flow x (PVF 16.00%, 5 Years)

= $1,068,000 x 3.274

= $3,496,632

Therefore, the Profitability Index = Present Value of annual cash inflows / Initial investment cost

= $3,496,632 / $2,915,000

= 1.20

**“Hence, the Project
profitability index for this project will be 1.20”**

**NOTE **

**The Formula for calculating
the Present Value Factor is [1/(1 + r) ^{n}], Where “r” is
the Discount/Interest Rate and “n” is the number of
years.**

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