Question

McKnight Company is considering two different, mutually exclusive capital expenditure proposals. Project A will cost $509,000, has an expected useful life of 12 years, a salvage value of zero, and is expected to increase net annual cash flows by $74,100. Project B will cost $342,000, has an expected useful life of 12 years, a salvage value of zero, and is expected to increase net annual cash flows by $50,700. A discount rate of 8% is appropriate for both projects.

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

Which project should be accepted based on Net Present Value?

Which project should be accepted based on profitability index?

Answer 1

Answer:

Particulars	Year	Cash Flow Project A	Cash Flow Project B	PVF @ 8%	PV Project A	PV Project B
Initial Cash outflow	0	509,000	342,000	1	509,000	342,000
Present value of cash outflows					509,000	342,000
Cash Inflows	1 to 12	74,100	50,700	7.5361	558,425	382,080
Present value of cash inflows					558,425	382,080
Net Present Value					49,425	40,080

Profitability Index Project A = 558,425/509000 i.e 1.0971

Profitability Index Project B = 382,080/342,000 i.e 1.1172

On the basis of NPV project A should be accepted and on the basis of profitability index project B should be accepted