Question

Complete the Differential Analysis for your business

CAVALRY is planning a party at a local orphanage and elementary. The project is operating at a loss, should CAVALRY discontinue this project?

Sales                            $2,400

COGS                            2,000

Gross Profit                      400

Operating Expenses           500

Loss from Operations   ($100)

*The company estimates that 20% of COGS are fixed and 60% of operating expenses are variable.

Should the company discontinue this project? Why or Why Not?

Complete the Capital Budgeting Analysis for a CAVALRY Investment:

CAVALRY is looking into investing into an inflatable obstacle course.The inflatable obstacle course has an initial investment of $4,000.The inflatable obstacle course will last for 8 years.If the obstacle course is purchased, CAVALRY will save $500 every year for 8 years because they will not have to rent the obstacle course.The CAVALRY discount rate is 8%

Is this an example of annuity or a present value of 1?

Should CAVALRY purchase the obstacle course?

What is profitability index (PI)?

If CAVALRY had another project, a popcorn machine, that had a profitability index of 1.5, and could only choose one project, which project should CAVALRY choose and why?

Answer 1

Question 1

Fixed expenses from COGS = 20% X 2000 = 400

Fixed expenses from operating expenses = 40% X 500 = 200

Total Fixed expenses = 600

Total Variable Expenses = 2000 + 500 - 600 = 1900

Contribution Margin = 2400 - 1900 = 600.

Contribution Margin % = 600/2400 = 25%;

The project currently generates a loss of 100. However, it has a positive contribution margin of 600 which indicates that increasing the sales by 400 (i.e. 100 loss/25%) would increase the profitability by 100 enabling the project to breakeven. If CAVALRY expects the party to generate at least another $400 in revenue it should continue the project. otherwise it should discountinue it.

Question 2

a. The Company receives an fixed benefit of $500 every year for a set period of time. Hence this is an Annuity

b. Initial investment = $4,000

Annual Cash Flow = 500

PV factor of 8% for cash inflows = 5.746639

PV of Cash Inflows = 500 X 5.746639 = 2,873.319

Net Present Value = PV of Cash Inflows - Initial Investment = 2,873.3 - 4000 = - $1,126.7

Since the Project generates a negative NPV, it should not be accepted.

c. The Profitability index is computed as PV of Inflows/Initial Investment

PI = 2873.3/4000 = 0.72

d. Since a profitability index of 1.5 indicates that the present value of the cash inflows from the popcorn project would be 1.5 times the initial investment, as compared to the 0.72 times of the obstacle course, the Company should take up the popcorn machin project as it would generate higher cash inflows.