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 IN EACH OF THE 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

1. 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?

2. 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?

3. 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?

Answer 1

1 Calculation of total cash flow Particulars Year 2 Year 5 Year 1 Year 3 Year 4 $ 27,35,000.00 $ 27,35,000.00 $ $-12,30,750.00 $-12,30,750.00 $ - 12,30,750.00 $-12,30,750.00 $-12,30,750.00 $ -7,35,000.00$ -7,35,000.00$ $ 1,69,250.00 $ 7,69,250.00 $ 27,35,000.00 $ 27,35,000.00 $ 27,35,000.00 Sales Variable expense Out of pocketcost Total cash flow -7,35,000.00 $ -7,35,000.00 $ -7,35,000.00 7,69,250.00 $ 7,69,250.00 $ 7,69,250.00 The varible expense $ 12,30,750.00 =2735000*45% Calculation of NPV It is given that the equipment cost is 2975000, projected net cash inflow is 769250, and cost of capital is 14%. Present value of Cost of capital net cash inflow (a)*(b)=© 0.877 $ Net cash Inflow (i=14%) (b) $ 7,69,250.00 $ 7,69,250.00 $ 7,69,250.00 $ 7,69,250.00 $ 7,69,250.00 Years Year 1 6,74,632.25 0.769 $ Year 2 5,91,553.25 0.675 $ Year 3 5,19,243.75 0.592 $ Year 4 4,55,396.00 0.519 $ Year 5 3,99,240.75 Present value of net cash inflow 26,40,066.00 $ - 29,75,000.00 Investment Net present value (loss) -3,34,934.00 2 Calculation of payback period It is given that the investment required is 2975000 and calculated annual net cash inflow is 769250. Investment required Annual net cash inflow Payback period $ 29,75,000.00 $ 7,69,250.00 3.78 years 3 Calculation of simple rate of return It is given that the annual incremental net operating income is 174250 and intial investment is 2975000 Annual incremental net operat$ 1,74,250.00 Initial investment $ 29,75,000.00 5.86% Simple rate of return