Required information [The following information applies to the questions display

Question

Required information [The following information applies to the questions displayed below.] 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 Variable expenses Contribution margin Fixed expenses: $ 2,855,000 1,010,000 1,845,000 Advertising, salaries, and other fixed out-of-pocket costs Depreciation $798,000 562,400 Total fixed expenses Net operating income 1,360,400 $ 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.) Project profitability index

Explanation / Answer

Step 1: Calculate Annual Net Cash Inflow

The value of annual net cash inflow is arrived as follows:

Annual Net Cash Inflow = Net Operating Income + Depreciation Expense

Using the values provided in the question in the above formula, we get,

Annual Net Cash Inflow = 484,600 + 562,400 = $1,047,000

____

Step 2: Calculate NPV

The NPV is calculated as below:

NPV = -Initial Investment + Annual Net Cash Inflow*PVIFA(Discount Rate, Years)

Using the information provided in the question and Present Value Factors, we get,

NPV = -2,812,000 + 1,047,000*PVIFA(16%,5) = -2,812,000 + 1,047,000*3.274 = $615,878

____

Step 3: Calculate Profitability Index

The formula for calculating profitability index is provided as below:

Profitabiity Index = NPV/Initial Investment = 615,878/2,812,000 = .22 (answer)

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