Question

Cardinal Company is considering a five-year project that would require a $2,812,000 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			$	2,855,000
Variable expenses				1,010,000
Contribution margin				1,845,000
Fixed expenses:
Advertising, salaries, and other fixed out-of-pocket costs	$	798,000
Depreciation		562,400
Total fixed expenses				1,360,400
Net operating income			$	484,600

Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using table.

5. What is the project profitability index for this project? (Round your answer to 2 decimal places.)

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

7. What is the project’s payback period? (Round your answer to 2 decimal places.)

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

Net operating income	484600
Add: Depreciation	562400
Annual cash flows	1047000
5
Annual cash flows	1047000
X PV factor	3.274	=(1-(1.16)^-5)/0.16
Present value of Annual cash flows	3427878
Less: Investment cost	2812000
Net present value	615878
Net present value	615878
Divide by Investment cost	2812000
Project profitability index	0.22
6
Investment cost	2812000
Divide by Annual cash flows	1047000
PV factor for Internal rate of return	2.686
Internal rate of return = 25%
7
Investment cost	2812000
Divide by Annual cash flows	1047000
Payback period	2.69	years
8
Net operating income	484600
Divide by Investment cost	2812000
Simple rate of return	17.23%

12

The project’s simple rate of return would be higher.

Salvage value would decrease depreciation expense and thereby increasing net operating income.