Question

Brief Exercise 26-5 McKnight Company is considering two different, mutually exclusive capital expenditure proposals. Project A will cost $450,241, has an expected useful life of 11 years, a salvage value of zero, and is expected to increase net annual cash flows by $73,500. Project B will cost $298,321, has an expected useful life of 11 years, a salvage value of zero, and is expected to increase net annual cash flows by $50,200. A discount rate of 9% 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 o 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 5 Profitability index - Project A Net present value - Project B Profitability index - Project B - Which project should be accepted based on Net Present Value? should be accepted. Which project should be accepted based on profitability index? should be accepted.

Answer 1

Computation of Net Presetn value of Project A
PV of Cash Inflow
PV of Annual Cash Flow	$500,182
( $73500X Cumm PVAF @9% for11 year)
($73500X 6.8052)
PV of Cash Inflow	$500,182
Less: Initial Investment	$450,241
Net Present Value	$49,941
Computation of Net Presetn value of Project B
PV of Cash Inflow
PV of Annual Cash Flow	$341,621
( $50200X Cumm PVAF @9% for 11 year)
($50200X 6.8052)
PV of Cash Inflow	$341,621
Less: Initial Investment	$298,321
Net Present Value	$43,300

Profitability Index Proect A= PV Annual Cash Flow/ Initial Investment

=500182/450241=1.11

Profitability Index Proect B= PV Annual Cash Flow/ Initial Investment

=341621/298321= 1.15

Project A Should be accepted based on NPV.

Project B Should be accepted based on Profitability Index