Question

Following is information on two alternative investments being considered by Jolee Company. The company requires a 6% return from its investments. (PV of $1, FV of $1, PVA of $1, and FVA of $1) (Use appropriate factor(s) from the tables provided.)

	Project A					Project B
Initial investment		$	(171,325	)			$	(149,960	)
Expected net cash flows in:
Year 1			48,000					33,000
Year 2			55,000					56,000
Year 3			78,295					54,000
Year 4			91,400					82,000
Year 5			54,000					31,000

a. For each alternative project compute the net present value.
b. For each alternative project compute the profitability index. If the company can only select one project, which should it choose?

Answer 1

Answer:

	Project A	Project B
a. Net Present Value	$101,396	$64,468
b. Profitability Index	1.59	1.43

Decision: Company should choose project A.

Calculation of net present value of both project:

Project A

Particulars	Period	PV Factor@6%	Amount	Present Value
Cash Inflow:
Expected net cash flows in:
Year -1	1 year	0.9434	$48,000	$45,283
Year -2	2 year	0.8900	$55,000	$48,950
Year-3	3 year	0.8396	$78,295	$65,736
Year-4	4 year	0.7921	$91,400	$72,398
Year-5	5 year	0.7473	$54,000	$40,354
Total Cash Inflow (a)				$272,721
Cash Outflow:
Initial investment	0	1	$171,325	$171,325
Total Cash Outflow (b)				$171,325
Net present value (a-b)				$101,396

Project B

Particulars	Period	PV Factor@6%	Amount	Present Value
Cash Inflow:
Expected net cash flows in:
Year -1	1 year	0.9434	$33,000	$31,132
Year -2	2 year	0.8900	$56,000	$49,840
Year-3	3 year	0.8396	$54,000	$45,338
Year-4	4 year	0.7921	$82,000	$64,952
Year-5	5 year	0.7473	$31,000	$23,166
Total Cash Inflow (a)				$214,428
Cash Outflow:
Initial investment	0	1	$171,325	$149,960
Total Cash Outflow (b)				$149,960
Net present value (a-b)				$64,468

Calculation of profitability index of both projects:

	Present value of cash inflow	/	Present value of cash outflow	=	Profitability Index
Project A	$272,721	/	$171,325	=	1.59
Project B	$214,428	/	$149,960	=	1.43