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
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
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