Question

Following is information on two alternative investments being considered by Jolee Company. The company requires a 8% 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		$	(184,325	)			$	(141,960	)
Expected net cash flows in:
Year 1			41,000					31,000
Year 2			43,000					59,000
Year 3			89,295					55,000
Year 4			95,400					71,000
Year 5			68,000					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

Project A

Cash outflow = 184,325

Cash inflow = cash *PVIF(8%,N)

1st year = 41,000*0.926 = 37,966

2nd year = 43,000*0.857 = 36,851

3rd year = 89,295*0.794 = 70,900

4th year = 95,400*0.735 = 70,119

5th year = 68,000* 0.681 = 46,308

Total = 262,144

Net present value = 262,144 - 184,325

= $ 77,819

Cash outflow = 141,960

Cash inflow = cash *PVIF(8%,N)

1st year = 31,000*0.926 = 28,706

2nd year = 59,000*0.857 = 50,563

3rd year = 55,000*0.794 = 43,670

4th year = 71,000*0.735 = 52,185

5th year = 31,000* 0.681 = 21,111

Total = 196,235

Present value = 196,235 - 141,960

= $ 54,275

As the present value of project A is Higher therefore it should be accepted.

B) Profitability index = Total cash inflow / investment

Project A

= 262,144/184,325

= 1.422

Project B

= 196,235/141,960

= 1.382

As the profitability index is higher of project A therefore it should be accepted.

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