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.