Cardinal Company is considering a project that would require

Cardinal Company is considering a project that would require a $2,865,000 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 12%. The project would provide net operating income each year as follows: Sales $ 2,869,000 Variable expenses 1,126,000 Contribution margin 1,743,000 Fixed expenses: Advertising, salaries, and other fixed out-of-pocket costs $ 709,000 Depreciation 513,000 Total fixed expenses 1,222,000 Net operating income $ 521,000

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

What is the project’s simple rate of return for each of the five years? (Round your answer to 2 decimal places. (i.e 0.1234 should be entered as 12.34.))

If the equipment’s salvage value was $500,000 instead of $300,000, what would be the project’s simple rate of return? (Round your answer to 2 decimal places. (i.e 0.1234 should be entered as 12.34.))

Assume a postaudit showed that all estimates (including total sales) were exactly correct except for the variable expense ratio, which actually turned out to be 50%. What was the project’s actual payback period? (Round your answer to 2 decimal places.)

Solution

a) Payback period = Initial investment/Annual cash flow

Annual cash flow = 521000+513000 = 1034000

Payback period = 2865000/1034000 = 2.77 Years

b) Simple rate of return = 521000*100/2865000 = 18.18%

c) Simple rate of return = 561000*100/2865000 = 19.58%

d) Net annual cash flow = 2869000*50%-1222000 = 212500+513000 = 725500

Payback period = 2865000/725500 = 3.95 Years