Question

Cardinal Company is considering a five-year project that would require a $2,915,000 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 $ 2,863,000
Variable expenses 1,014,000
Contribution margin 1,849,000
Fixed expenses:
Advertising, salaries, and other fixed out-of-pocket costs $ 781,000
Depreciation 583,000
Total fixed expenses 1,364,000
Net operating income $ 485,000

15. 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? (Round your answer to 2 decimal places.)

Answer 1

The initial investment is $2,915,000. The annual net operating income is $485,000. The project's simple rate of return is the annual net operating income divided by the initial investment.

The variable expense ratio is 45%, which means that the variable expenses are $2,863,000 x 45% = $1,288,350.

The contribution margin is $2,863,000 - $1,288,350 = $1,574,650.

The fixed expenses are $781,000 + $583,000 = $1,364,000.

The net operating income is $1,574,650 - $1,364,000 = $210,650.

The simple rate of return is $210,650 / $2,915,000 = 7.22%.

Therefore, the project's actual simple rate of return is 7.22%.