Question

Kanye Company is evaluating the purchase of a rebuilt spot-welding machine to be used in the manufacture of a new product. The machine will cost $179,000, has an estimated useful life of 7 years, a salvage value of zero, and will increase net annual cash flows by $39,222.

McKnight Company is considering two different, mutually exclusive capital expenditure proposals. Project A will cost $519,277, has an expected useful life of 12 years, a salvage value of zero, and is expected to increase net annual cash flows by $71,600. Project B will cost $367,031, has an expected useful life of 12 years, a salvage value of zero, and is expected to increase net annual cash flows by $51,800. A discount rate of 7% 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 $Entry field with incorrect answer Profitability index - Project A Entry field with incorrect answer Net present value - Project B $Entry field with incorrect answer Profitability index - Project B

Answer 1

1. Kanye Company

Initial Investment = $179,000

Life of Project = 7 years

Net Increase in Cash Flows = $39,222

Discount Rate = 7% (Only 7% discount rate is mentioned in the question)

Net Present Value = (Net Increase in cash flows * Annuity factor of 7% for 7 years) - Initial Investment

= ($39,222 * 5.389289) - $179,000

= $211,378.71 - $179,000

= $32,378.71

2. McKnight Company

Project A

Initial Investment = $519,277

Life of Project = 12 years

Increase in Net Annual Cash Flow = $71,600

Discounting Rate = 7%

Net Present Value = (Net Increase in cash flows * Annuity factor of 7% for 12 years) - Initial Investment

= ($71,600 * 7.942686) - $519,277

= $49,419.32

Profitability Index = PV of Cash Inflows / PV of Cash Outflows

= $568,696.32 / $519,277

= 1.095

Project B

Initial Investment = $367,031

Life of Project = 12 years

Increase in Net Annual Cash Flow = $51,800

Discounting Rate = 7%

Net Present Value = (Net Increase in cash flows * Annuity factor of 7% for 12 years) - Initial Investment

= ($51,800 * 7.942686) - $367,031

= $44,400.13

Profitability Index = PV of Cash Inflows / PV of Cash Outflows

= $411,431.13 / $367,031

= 1.121