Question

Cardinal Company is considering a five-year project that would require a $2,975,000 investment in equipment with a useful life of five years and no salvage value. The company’s discount rate is 14%. The project would provide net operating income in each of five 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		595,000
Total fixed expenses				1,330,000
Net operating income			$	405,000

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? (Round discount factor to 3 decimal places.)

3. What is the project’s net present value? (Round discount factor(s) to 3 decimal places.)

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

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

Answer 1

ANSWER:

(A)

Annual net cash inflow = net operating income + depreciation

= $405000 + $595000

= $1000000

NOTE: depreciation is a non-cash expenses, therefore it is ADDED BACK to the net operating income while arriving at cash inflow.

(B)

PVAF(14% , 5) = 3.433

Therefore,

Present value of annual net cash flow = $1000000 x 3.433

= $3433000

(C)

Net present value = present value of annual net cash flow - initial investment

= $3433000 - $2975000

= $458000

(D)

Profitability index = present value of annual net cash flow/initial investment

= $3433000/$2975000

= 1.15