Question

Cardinal Company is considering a five-year project that would require a $3,025,000 investment in equipment with a useful life of five years and no salvage value. The company's discount rate is 16%. The project would provide net operating income in each of five years as follows:

Sales $2,737,000

Variable expenses $1,001,000

Contribution margin $1,736,000

Fixed expenses:

Advertising, salaries, and other fixed out-of-pocket costs $610,000

Depreciation $605,000

Total fixed expenses $1,215,000

Net operating income $521,000

5. What is the project profitability index for this project? (Round your answer to 2 decimal places.)

Answer 1

Answer:

Calculation of profitability index of the project as follows:

Profitability index = Present value of cash inflow / Present value of cash outflow

= $3,686,524 / 3,025,000

   = 1.22

Therefore, profitability index for this project is 1.22

Working Note-1:

Calculation of present value of cash inflow and outflow as follows:

Present value of cash inflow = (Cash inflow x PV factor for 1-5 year)

= $1,126,000 x 3.274

= $3,686,524

Present value of cash outflow = (Initial investment x PV Factor for 0 period)

= $3,025,000

Working Note-2:

Calculation of cash inflow of project for each of the five years as follows:

Cash inflow = (Net operating income + Depreciation)

   = ($521,000 + $605,000)

= $1,126,000