Question

Cardinal Company is considering a project that would require a $2,500,000 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

$

2,853,000   

  Variable expenses

1,200,000   

  Contribution margin

1,653,000   

  Fixed expenses:

  Advertising, salaries, and other
    fixed out-of-pocket costs

$

790,000

  Depreciation

460,000

  Total fixed expenses

1,250,000   

  Net operating income

$

403,000   

What are the project’s annual net cash inflows?

3.

What is the present value of the project’s annual net cash inflows?

4.

What is the present value of the equipment’s salvage value at the end of five years?

5.

What is the project’s net present value?

6.

What is the project profitability index for this project?

7.

What is the project’s payback period?

8.

What is the project’s simple rate of return for each of the five years?

12.

If the equipment’s salvage value was $400,000 instead of $200,000, what would be the project’s simple rate of return?

Assume a postaudit showed that all estimates (including total sales) were exactly correct except for the variable expense ratio, which actually turned out to be 50%. What was the project’s actual net present value?

14.

Assume a postaudit showed that all estimates (including total sales) were exactly correct except for the variable expense ratio, which actually turned out to be 50%. What was the project’s actual payback period? Assume a postaudit showed that all estimates (including total sales) were exactly correct except for the variable expense ratio, which actually turned out to be 50%. What was the project’s actual simple rate of return?

Answer 1

Answer to Question 1:

Annual Net Cash Inflows = Net Operating Income + Depreciation
Annual Net Cash Inflows = $403,000 + $460,000
Annual Net Cash Inflows = $863,000

Answer to Question 3:

Discount Rate = 12%

Present Value of Annual Net Cash Inflow = $863,000 * PVA of $1 (12%, 5)
Present Value of Annual Net Cash Inflow = $863,000 * 3.6048
Present Value of Annual Net Cash Inflow = $3,110,942.40

Answer to Question 4:

Salvage Value = $200,000

Present Value of Salvage Value = $200,000 * PV of $1 (12%, 5)
Present Value of Salvage Value = $200,000 * 0.5674
Present Value of Salvage Value = $113,480.00

Answer to Question 5:

Net Present Value = Initial Cost + Present Value of Annual Net Cash Inflow + Present Value of Salvage Value
Net Present Value = -$2,500,000 + $3,110,942.40 + $113,480.00
Net Present Value = $724,422.40