Question

Beacon Company is considering two different, mutually exclusive capital expenditure proposals. Project A will cost $480,826, has an expected useful life of 13 years, a salvage value of zero, and is expected to increase net annual cash flows by $71,600. Project B will cost $317,605, has an expected useful life of 13 years, a salvage value of zero, and is expected to increase net annual cash flows by $49,100. A discount rate of 9% is appropriate for both projects. (Refer the below table) compute the net present value and probability index of each project

Answer 1

Project A:

Initial Cost = $480,826
Annual Cash Flows = $71,600
Life of Project = 13 years
Discount Rate = 9%

Present Value of Cash Flows = $71,600 * PVA of $1 (9%, 13)
Present Value of Cash Flows = $71,600 * 7.4869
Present Value of Cash Flows = $536,062.04

Net Present Value = Present Value of Cash Flows - Initial Cost
Net Present Value = $536,062.04 - $480,826
Net Present Value = $55,236.04

Profitability Index = Present Value of Cash Flows / Initial Cost
Profitability Index = $536,062.04 / $480,826
Profitability Index = 1.11

Project B:

Initial Cost = $317,605
Annual Cash Flows = $49,100
Life of Project = 13 years
Discount Rate = 9%

Present Value of Cash Flows = $49,100 * PVA of $1 (9%, 13)
Present Value of Cash Flows = $49,100 * 7.4869
Present Value of Cash Flows = $367,606.79

Net Present Value = Present Value of Cash Flows - Initial Cost
Net Present Value = $367,606.79 - $317,605
Net Present Value = $50,001.79

Profitability Index = Present Value of Cash Flows / Initial Cost
Profitability Index = $367,606.79 / $317,605
Profitability Index = 1.16