Question

Cardinal Company is considering a five-year project that would require a $2,500,000 investment in equipment with a useful life of five years and no salvage value. The company’s discount rate is 12%. The project would provide net operating income in each of five years as follows:

Sales			$	2,853,000
Variable expenses				1,200,000
Contribution margin				1,653,000
Fixed expenses:
Advertising, salaries, and other fixed out-of-pocket costs	$	790,000
Depreciation		500,000
Total fixed expenses				1,290,000
Net operating income			$	363,000
3. What is the present value of the project’s annual net cash inflows? 5. What is the project profitability index for this project? 7. What is the project’s payback period? 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 50%. What was the project’s actual net present value? 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 50%. What was the project’s actual payback period?

Answer 1

Solution 3:

Project annual cash inflows = Net operating income + Depreciation = $363,000 + $500,000 =$863,000

Present value of Project annual net cash inflows = $863,000 * Cumulative PV Factor at 12% for 5 periods = $863,000 *3.604776

= $3,110,922

Solution 5:

Profitablity index = Present value of cash inflow / Initial investment = $3,110,922 / $2,500,000 = 1.24

Solution 7:

Payback period = Intitial investment / Annual cash inflows = $2,500,000 / $863,000 = 2.90 years

Solution 13:

Actual variable expenses = $2,853,000*50% = $1,426,500

Increase in variable expenses = $1,426,500 - $1,200,000 = $226,500

Actual cash inflows = $863,000 - $226,500 = $636,500

Computation of NPV
Particulars	Period	PV Factor (12%)	Amount	Present Value
Cash outflows:
Initial investment	0	1	$2,500,000	$2,500,000
Present Value of Cash outflows (A)				$2,500,000
Cash Inflows
Annual Cash inflows	1-5	3.604776	$636,500.00	$2,294,440
Present Value of Cash Inflows (B)				$2,294,440
Net Present Value (NPV) (B-A)				-$205,560

Solution 14:

Actual payback period = $2,500,000 / $636,500 = 3.93 years