Question

CARDINAL COMPANY IS CONSIDERING A FIVE-YEAR PROJECT THAT WOULD REQUIRE A $2,975,000 INVESTMENT IN EQUIPMENT WITH A USEFUL LIFE OF YEARS AND NO SALVAGE VALUE. THE COMPANY'S DISCOUNT RATE IS 14%. THE PROJECT WOULD PROVIDE NET OPERATING INCOME EACH OF THE 5 YEARS AS FOLLOWS:

SALES                                                        $2,735,000

VARIABLE EXPENSES                                 1,000,000

CONTRIBUTION MARGIN                             $1,735,000

FIXED EXPENSES:

ADVERTISING, SALARIES, AND OTHER FIXED OUT OF POCKET COSTS              $735,000

DEPRECIATION                                                                                                        $ 95,000

TOTAL FIXED EXPENSES                                                                                                                $1,330,000

NET OPERATING EXPENSES                                                                                                          $ 405,000

1. WHAT IS THE PROJECT PROFITABILITY INDEX FOR THIS PROJECT? (ROUND YOUR ANSWER TO THE NEAREST WHOLE PERCENT)

2. WHAT IS THE PROJECT INTERNAL RATE OF RETURN TO THE NEAREST WHOLE PERCENT?

3. WHAT IS THE PROJECT'S PAYBACK PERIOD?

4. WHAT IS THE PROJECT'S SIMPLE RATE OF RETURN FOR EACH OF THE FIVE YEARS?

Answer 1

	Note: Net operating expenses do not tally with total depreciation and advertising expenses.
	Following answer given by assuming that depreciation is $595000 instead of $95000.
1)	Annual Operating Cash Flow = Net income + Depreciation
			=$405000+595000
			=$1000000
	Profitability index
a	Annual Cash Inflow			$         10,00,000
b	PVA Factor 5 years,14%			3.4331
c	PV of Cash Inflow (a*b)			$         34,33,081
d	Initial Investment			$         29,75,000
e	Profitability Index (d/e)			1.15
f	Profitability Index In %			115%
2)	For IRR let us calculate NPV at 14% and 21 % discounting rate
				at 14%	at 21%
a	Annual Cash Inflow			$         10,00,000	$   10,00,000
b	PVA Factor 5 years,14%			3.4331	2.9260
c	PV of Cash Inflow (a*b)			$         34,33,081	$   29,25,984
d	Initial Investment			$         29,75,000	$   29,75,000
e	NPV (c-d)			$            4,58,081	$       -49,016
	IRR = 14% + [458081/(458081+49016)] *21-14
	=14% +6.32%
	=20.32% (Approx)
	=20.24% (Exact, using excel function)
	Please prefer exactly.
3)	Payback Period = Initial investment / annual cash inflow
	=$2975000/1000000
	2.975	years
4)	Simple Rate Of Return= Net Income / Initial Investment
	=$405000/2975000
	13.61%
	Let me know the wrong answer.