Question

Cardinal Company is considering a five-year project that would require a $2,850,000 investment in equipment with a useful life of five years and no salvage value. The company’s discount rate is 18%. The project would provide net operating income in each of five years as follows:

Sales | $ | 2,857,000 | ||

Variable expenses | 1,011,000 | |||

Contribution margin | 1,846,000 | |||

Fixed expenses: | ||||

Advertising, salaries, and other fixed out-of-pocket costs | $ | 799,000 | ||

Depreciation | 570,000 | |||

Total fixed expenses | 1,369,000 | |||

Net operating income | $ | 477,000 | ||

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

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

Answer #1

**Solution 5:**

Annual cash inflows = Net operating income + Depreciation = $477,000 + $570,000 = $1,047,000

Computation of Project profitability index - Cardinal
Company |
||||

Particulars |
Amount |
Period |
PV Factor |
Present Value |

Cash Outflows: |
||||

Cost of Equipment | $2,850,000.00 | 0 | 1 | $2,850,000 |

Present Value of Cash Outflows (A) |
$2,850,000 |
|||

Cash Inflows: |
||||

Annual cash inflows | $1,047,000.00 | 1-5 | 3.127 | $3,273,969 |

Present Value of Cash Inflows (B) |
$3,273,969 |
|||

Net Present Value (B-A) |
$423,969 |
|||

Profitability Index (NPV / Initial
investment) |
0.149 |

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Variable expenses
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Contribution margin
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Cardinal Company is considering a five-year project that would
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