Question

McKnight Company is considering two different, mutually exclusive capital expenditure proposals. Project A will cost $511,000, has an expected useful life of 12 years, a salvage value of zero, and is expected to increase net annual cash flows by $74,300. Project B will cost $330,000, has an expected useful life of 12 years, a salvage value of zero, and is expected to increase net annual cash flows by $49,600. A discount rate of 8% is appropriate for both projects. Click here to view PV table.

Compute the net present value and profitability index of each project. (If the net present value is negative, use either a negative sign preceding the number eg -45 or parentheses eg (45). Round present value answers to 0 decimal places, e.g. 125 and profitability index answers to 2 decimal places, e.g. 15.25. For calculation purposes, use 5 decimal places as displayed in the factor table provided.)

Net present value - Project A $

Profitability index - Project A

Net present value - Project B $

Profitability index - Project B

Which project should be accepted based on Net Present Value? choice project a/ project b

Which project should be accepted based on profitability index? choice project a/ project b

Answer 1

1	Calculation of Net present value of each Project :-
			Project A	Project B
a	Initial Investment (Cost of equipment)	=	$                    511,000	$          330,000
b	Estimated Net Annual Cash inflows	=	$                      74,300	$             49,600
c	Present Value of an Annuity of Rs.1 @ 8% for 12 years	=	7.53608	7.53608
d	Present Value of Estimated Annual Net cash Inflows (b*c)	=	$559,931	$373,789
e	Net present value (d-a)	=	$48,931	$43,789
2	Calculation of profitability index for each Project :-
			Project A	Project B
a	Initial Investment (Cost of equipment)	=	$                    511,000	$          330,000
b	Present Value of Estimated Annual Net cash Inflows	=	$                    559,931	$          373,789
c	Project profitability index (b/a)	=	1.10	1.13
3	Which project should be accepted based on Net Present Value?
Ans:	Project A should be accepted
Explanation:	Project A has $48931 net present value which is higher than $43789 that of Project B.
4	Which project should be accepted based on profitability index?
Ans:	Project B should be accepted
Explanation:	Project B has 1.13 profitability index which is higher than 1.10 that of Project A.

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