Question

Part Five

APPLY THE CONCEPTS: Net present value and Present value index

Underwood Engineering is looking to invest in Project A or Project B. The data surrounding each project is provided below. Underwood's cost of capital is 10%.
Project A	Project B
This project requires an initial investment of $170,000. The project will have a life of 3 years. Annual revenues associated with the project will be $130,000 and expenses associated with the project will be $35,000.	This project requires an initial investment of $137,500. The project will have a life of 5 years. Annual revenues associated with the project will be $113,000 and expenses associated with the project will be $60,000.

Calculate the net present value and the present value index for each project using the present value tables provided below.

Present Value of $1 (a single sum) at Compound Interest.

Present Value of an Annuity of $1 at Compound Interest.

Note:
•	Use a minus sign to indicate a negative NPV.
•	If an amount is zero, enter "0".
•	Enter the present value index to 2 decimals.

	Project A		Project B
Total present value of net cash flow	$		$
Amount to be invested
Net present value	$		$
Present value index:
Project A
Project B

Based upon net present value, which project has the more favorable profit prospects?   Project A

Based upon the present value index, which project is ranked higher?   Project B

Answer 1

	Project A	Project B
Total present value of net cash flow	$236251	$200912
Amount to be invested	170000	137500
Net present value	66251	63412
Present value index:
Project A	1.39
Project B	1.46

Based upon net present value, Project A has the more favorable profit prospects. (as it has higher NPV)

Based upon the present value index, Project B is ranked higher (as it has higher present value index)

Part A              

Project A

Initial investment = $170000

Net annual cash flow = annual revenues – annual expenses = 130000-35000 = $95000

Total present value of net cash flow = Net annual cash flow * Present Value of an Annuity of $1 for i= 10%, n = 3 = 95000*2.48685 = $236251

Net present value = Total present value of net cash flow – initial investment = 236251-170000 = $66251

Project B

Initial investment = $137500

Net annual cash flow = annual revenues – annual expenses = 113000-60000 = $53000

Total present value of net cash flow = Net annual cash flow * Present Value of an Annuity of $1 for i= 10%, n = 5 = 53000*3.79079 = $200912

Net present value = Total present value of net cash flow – initial investment = 200912-137500 = $63412

Part B

Project A

Present value index = Present value of cash inflows / Initial investment = 236251/170000 = 1.39

Project B

Present value index = Present value of cash inflows / Initial investment = 200912/137500 = 1.46