Question

Cardinal Company is considering a five-year project that would require a $2,800,000 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			$	2,845,000
Variable expenses				1,109,000
Contribution margin				1,736,000
Fixed expenses:
Advertising, salaries, and other fixed out-of-pocket costs	$	799,000
Depreciation		560,000
Total fixed expenses				1,359,000
Net operating income			$	377,000

1. What is the project profitability index for this project?

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

Answer 1

Net operating income	377000
Add: Depreciation	560000
Net annual cash flows	937000
1
Net annual cash flows	937000
X PV factor 14%	3.433	=(1-(1.14)^-5)/0.14
Present value of Net annual cash flows	3216721
Less: Investment cost	2800000
Net Present value	416721
Net Present value	416721
Divide by Investment cost	2800000
Project profitability index	0.15
2
Net operating income	377000
Divide by Investment cost	2800000
Simple rate of return	13.46%