Question

Cardinal Company is considering a five-year project that would require a $2,955,000 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			$	2,871,000
Variable expenses				1,018,000
Contribution margin				1,853,000
Fixed expenses:
Advertising, salaries, and other fixed out-of-pocket costs	$	753,000
Depreciation		591,000
Total fixed expenses				1,344,000
Net operating income			$	509,000

Click here to view Exhibit 12B-1 and Exhibit 12B-2, to determine the appropriate discount factor(s) using table.

9. If the company’s discount rate was 18% instead of 16%, would you expect the project's net present value to be higher, lower, or the same?

13. 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 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.)

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 45%. What was the project’s actual payback period? (Round your answer to 2 decimal places.)

15. 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 45%. What was the project’s actual simple rate of return? (Round your answer to 2 decimal places.)   

12. If the equipment had a salvage value of $300,000 at the end of five years, would you expect the project’s simple rate of return to be higher, lower, or the same?

Answer 1

9. If the company's discounting rate is increased from 16% from 18%, the Net Present Value of the project will decrease because the expected rate of return is increased but the return from the project in monetary terms will remain the same.

13. Post audit variable Ratio turns out to be 45%. Therefore, to calculate actual NPV of the project, we will have to consider variable as 45% of sales

NPV = Present Value of Net Operating Cash Flows at cumulative discounting factor of 16% for 5 years - Initial Investment in equipment

Initial Investment in Equipment = $2,955,000

Cumulative discounting factor of 16 % for 5 years = 3.274

Net Operating Cash Flow = Contribution Margin - Fixed Expenses(excluding depreciation because depreciation is non cash expenditure)

= 55% of Sales - Fixed Expenses

   = $1,579,050 - $753,000

= $826,050

NPV = ($826,050 * 3.274) - $2,955,000

= $2,704,487.70 -  $2,955,000

= -$250,512.30

14. With the given facts of the question, we can see that the cash flows of all the years are equal. Therefore pay back period can be calculated as

Pay Back Period = Investment on Project / Annual Operating Cash Flow

= $2,955,000 / $826,050

= 3.577 years

15. The project's actual simple rate of return can be computed as

Simple rate of return = (Net operating Income / Initial Investment) * 100

Net Operating Income = Net operating cash flow - Depreciation

= $826,050 - $591,000

= 235,050

Simple Rate of Return = ($235,050 / $2,955,000) *100

= 7.95%

12. If the equipment had a salvage value of $300,000, the project's simple rate of return will increase.