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