Question

Cardinal Company is considering a project that would require a $2,765,000 investment in equipment with a useful life of five years. At the end of five years, the project would terminate and the equipment would be sold for its salvage value of $200,000. The company’s discount rate is 12%. The project would provide net operating income each year as follows:

  

Sales			$	2,861,000
Variable expenses				1,101,000
Contribution margin				1,760,000
Fixed expenses:
Advertising, salaries, and other     fixed out-of-pocket costs	$	705,000
Depreciation		513,000
Total fixed expenses				1,218,000
Net operating income			$	542,000

    
Click here to view Exhibit 11B-1 and Exhibit 11B-2, to determine the appropriate discount factor(s) using tables.

Required:

What is the project profitability index for this project? (Round discount factor(s) to 3 decimal places and final answer to 2 decimal places.)

  

Project profitability index

If you could show the work to get this please........thank you!

Answer 1

Answer

Annual Cash Inflow = Net Operating Income + Depreciation (Non-Cash Expense)

Annual Cash Inflow = $1,055,000 (542,000 + 513,000)

Cash Inflow (Salvage value of Equipment) at the end of 5^th Year = $200,000

PVAF @12% for 5 Years = 3.605

PV @12% for 5^th Year = 0.567

Present Value of Cash Inflows = Present Value of Annual Cash Inflow for 5 Years + Present Value of Annual Cash Inflow at the end of 5^th Year

= ($1,055,000 * 3.605) + ($200,000 * 0.567)

Present Value of Cash Inflows = $3,916,675

Present Value of Cash Outflow = $2,765,000

Profitability Index = Present Value of Cash Inflow / Present Value of Cash Outflow

= $3,916,675 / $2,765,000

Profitability Index = 1.42