Cardinal Company is considering a fiveyear project that woul

Cardinal Company is considering a five-year project that would require a $2,860,000 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 Variable expenses Contribution margin Fixed expenses: $ 2,859,000 1,100,00e 1,759,0e0 Advertising, salaries, and other fixed out-of-pocket costs Depreciation 700,000e 572,000 Total fixed expenses Net operating income 1,272,000 $ 487,000 Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using table.

Solution

Calculation of Cash Generated each year Sales $ 2,859,000.00 Variable Expenses $ 1,100,000.00 Contribution Margin $ 1,759,000.00 Fixed Expenses     Advertisement, Salaries and Other Out of Pocket Expenses $        700,000.00     Depreciiation $        572,000.00 Total Fixed Expenses $ 1,272,000.00 Net Operating Income $      487,000.00 Add: Non cash Expense- Depreciation $      572,000.00 Net Cash Generated During the Year $ 1,059,000.00 1) Correct Option is (D) Depreciation Expenses    Reason: Depreciation will not affect cash flow as it is a non cash expense. It is a manufacturing expense but not paid in cash. 2) Projects Annual Net Cash Inflows = 1059000 3) Calculation of Present Value of net cash Inflow for five years Cash Inflow for 5 Years (A) $           1,059,000 Annuity Factor for Five years at Discount rate of 14% (B) 3.433 Present Value of Cash flow of 5 Years (C=A*B) $           3,635,547 4) Projects Net Present value        Present value of cash Inflows $           3,635,547         Less Present value of Cash outflow $     2,860,000.00 $              775,547 5) Profitability Index Net Present Value of Inflows/ Present value of Outflows (3635547/2860000)= 1.27