Question

Jonczyk Company is considering two different, mutually exclusive Capital expenditure proposals. Project A will cost $445,000, has an epected useful life of 14 years and a salvage value of zero, and is expected to increase net annual cash flows by $68,000. Project B will cost325,00, has an expected useful life of 14 years and a salvage value of zero, and is expected to increase net annual cash flows by $51,000. A discount rate of 10% is appropriate for both projects. Click here to view PV table.

 

Answer 1

Net Present value = Present value of cash inflows - Cost of the investment

Net Present value of Project A = Annual cash inflows x PVIA (10%, 14 years) - Cost of the investment

= $68,000 x 7.36669 - $445,000

= $500,935 - $445,000

= $55,935

Net Present value of Project B = Annual cash inflows x PVIA (10%, 14 years) - Cost of the investment

= $51,000 x 7.36669 - $325,000

= $375,701 - $325,000

= $50,701

Profitability index = Present value of cash inflows / Cost of the investment

Profitability index of Project A = Annual cash inflows x PVIA (10%, 14 years) / Cost of the investment

= $68,000 x 7.36669 / $445,000

= $500,935 / $445,000

= 1.13

Profitability index of Project B = Annual cash inflows x PVIA (10%, 14 years) / Cost of the investment

= $51,000 x 7.36669 / $325,000

= $375,701 / $325,000

= 1.16

Project A should be accepted based on net present value.

Project B should be accepted based on Profitability index.