Question

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

Answer 1

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