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Brief Exercise 12-5 McKnight Company is considering two different, mutually exclusive capital expenditure proposals. Project A...

Brief Exercise 12-5

McKnight Company is considering two different, mutually exclusive capital expenditure proposals. Project A will cost $435,000, has an expected useful life of 11 years, a salvage value of zero, and is expected to increase net annual cash flows by $74,600. Project B will cost $253,000, has an expected useful life of 11 years, a salvage value of zero, and is expected to increase net annual cash flows by $45,200. A discount rate of 10% 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

Solutions

Expert Solution

McKnight Company is considering two different, mutually exclusive capital expenditure proposals. Project A will cost $435,000, has an expected useful life of 11 years, a salvage value of zero, and is expected to increase net annual cash flows by $74,600. Project B will cost $253,000, has an expected useful life of 11 years, a salvage value of zero, and is expected to increase net annual cash flows by $45,200. A discount rate of 10% is appropriate for both projects. Click here to view PV table.



Compute the net present value and profitability index of each project.

MC Knight Company

P.v of annuity factor 10% for 11 years  =( 1 / 1 + 10%)^11GT

6.495061

Project A

Project B

Initial cost

$435000

$253000

Expected increase in net annual cash flow

74600

45200

P.V of cash flow= annual cash flow * P.v of annuity factor 10% for 11

74600*6.495061

=484531.55

45200*6.495061

=293576.76

NPV= Present value of inflow - Present value of outflow

484531.55 - 435000

293576.76- 253000

NPV

49532

40577

Project A should be accepted on the basis of NPV

Profitability Index = Present value of cash flow / initial cost

P.V of cash flow

484531.55

293576.76

Initial cost

$435000

$253000

Profitability Index

484531.55 / 435000

=1.11

293576.76 / 253000

=1.16

***

Net present value - Project A

$49532

Profitability index - Project A

1.11

Net present value - Project B

$40577

Profitability index - Project B

1.16

NPV= Under mutually exclusive project, a project with higher NPV will accept


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