In: Accounting
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 |
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