8. If the equipment’s salvage value was $700,000 instead of $500,000, what would

Question

8. If the equipment’s salvage value was $700,000 instead of $500,000, what would be the project’s simple rate of return?

9. 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 45%. What was the project’s actual net present value?

10.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 45%. What was the project’s actual payback period?

11. 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 45%. What was the project’s actual simple rate of return?

Cardinal Company is considering a project that would require a $2,815,000 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 $500,000. The company's discount rate is 18%. The project would provide net operating income each year as follows: Sales Variable expenses $2,865,000 1,015,000 1,850,000 Contribution margin Fixed expenses: Advertising, salaries, and other fixed out-of-pocket costs $750,000 463,000 Total fixed expenses 1,213,000 Net operating income $ 637,000

Explanation / Answer

8. Simple rate of return = Accounting income / Net investment in the project x 100

If salvage value is $ 700,000 , simple rate of return = $ 637,000 /( $ 2,815,000 - $ 700,000) = 30.12%

9. If the variable expense ratio is 45%, contribution margin ratio is 55%.

Therefore cash flows = $ 2,865,000 x 55% - 750,000 = $ 825,750

Net present value at discount rate of 18% = $ 825,750 x 3.127 + $ 500,000 x 0.437 - $ 2,815,000 = $ 2,582,120 + $ 218,500 - $ 2,815,000 = $ (14,380)

10. Payback period = Initial investment / Annual cash inflows = $ 2,815,000 / $ 825,750 = 3.41 years

11. Simple rate of return = $ ( 825,750 - 463,000) / $ 2,315,000 x 100 = 15.67%

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