Question

Cardinal Company is considering a five-year project that would require a $2,915,000 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			$	2,863,000
Variable expenses				1,014,000
Contribution margin				1,849,000
Fixed expenses:
Advertising, salaries, and other     out-of-pocket costs	$	781,000
Depreciation		583,000
Total fixed expenses				1,364,000
Net operating income			$	485,000

(Hint: Use Microsoft Excel to calculate the discount factor(s).)

 

Respond with workings:

2-a. What are the project’s annual net cash inflows?

2-b. What is the present value of the project’s annual net cash inflows?

3. What is the project’s net present value? (Round discount factor(s) to 3 decimal places and final answer to the nearest whole dollar amount.)

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

5. What is the project’s internal rate of return? (Round your answer to nearest whole percent.)

6. What is the project’s payback period?

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

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12. Assume a post-audit showed that all estimates (including total sales) were exactly correct except for the variable expense ratio, which actually turned out to be 45%. What was the project’s actual net present value? (Negative amount should be indicated by a minus sign. Round discount factor(s) to 3 decimal places, intermediate calculations and final answer to the nearest whole dollar amount.)

13. Assume a post-audit showed that all estimates (including total sales) were exactly correct except for the variable expense ratio, which actually turned out to be 45%. What was the project’s actual payback period? (Round your answer to 2 decimal places.)

14. Assume a post-audit showed that all estimates (including total sales) were exactly correct except for the variable expense ratio, which actually turned out to be 45%. What was the project’s actual simple rate of return? (Round your answer to 2 decimal places. i.e. 0.12342 should be considered as 12.34%.)

Answer 1

Solution 12:

If the equipment had a salvage value of $300,000 at the end of five years, the project’s simple rate of return to be higher, as annual net operating income will be higher due to lower depreciation.

Solution 13:

Computation of NPV - Cardinal Company
Particulars	Amount	Period	PV Factor	Present Value
Cash Outflows:
Cost of Equipment	$2,915,000.00	0	1	$2,915,000
Present Value of Cash Outflows (A)				$2,915,000
Cash Inflows:
Annual cash inflows	$793,650.00	1-5	3.274	$2,598,410
Present Value of Cash Inflows (B)				$2,598,410
Net Present Value (B-A)				-$316,590

Answer 2

Solution 5:

Present Value of Cash Inflows = $1,068,000 * PVA of $1 (16%, 5)
Present Value of Cash Inflows = $1,068,000 * 3.27429
Present Value of Cash Inflows = $3,496,941.72

Profitability Index = Present Value of Cash Inflows / Initial Investment
Profitability Index = $3,496,941.72 / $2,915,000
Profitability Index = 1.20

Solution 7:

Payback Period = Initial Investment / Annual Net Cash flows
Payback Period = $2,915,000 / $1,068,000
Payback Period = 2.73 years

Answer 3

Sales	2863000
Variable expenses	1288350	=2863000*45%
Contribution margin	1574650
Fixed expenses:
Advertising, salaries, and other fixed out-of-pocket costs	781000
Depreciation	583000
Total fixed expenses	1364000
Actual Net operating income	210650
Solution 14:
Investment cost	2915000
Divide by Annual cash flows	793650	=210650+583000
Actual payback period	3.67	years
Solution 15:
Actual Net operating income	210650
Divide by Investment cost	2915000
Actual simple rate of return	7.23%