Cardinal Company is considering a project that would require

Cardinal Company is considering a project that would require a $2,755,000 investment in equipment with a useful life of five years. At the end of five years, the project would terminate and the equipment would be sold for its salvage value of $300,000. The company’s discount rate is 14%. The project would provide net operating income each year as follows

2. What is the present value of the equipment’s salvage value at the end of five years?

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

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

5. What is the project’s payback period?

Solution

(1) Present value of the project’s annual net cash inflows

Annual Cash Flow = Net Operating Income + Depreciation

= $568,000 + 491,000

= $10,59,000

Present value of the project’s annual net cash inflows

= Annual cashflows x [PVIFA 14%, 5 Years]

= $10,59,000 x 3.43308097

= $ 36,35,632.75

(2) - Present value of the equipment’s salvage value at the end of five years

Present value of the equipment’s salvage value = Salvage Value x [PVIF 14%, 5 Years]

= $300,000 x 0.51936867

= $ 1,55,810.60

(3) - Profitability Index for this project

Profitability Index = [Present value of cashflows + Present Value of salvage Value] / Initial Investment

= [$ 36,35,632.75 + $ 1,55,810.60] / $27,55,000

= $37,91,443 / 27,55,000

= 1.38

(5) - Project’s payback period

Payback Period = Initial Investment / Annual cash inflows

= $27,55,000 / $10,59,000

= 2.60 Years

***The Question No 3 & 4 are same questions, hence only Question 3 is solved