Question

McKnight Company is considering two different, mutually exclusive capital expenditure proposals. Project A will cost $400,000, has an expected useful life of 10 years, a salvage value of zero, and is expected to increase net annual cash flows by $70,000. Project B will cost $310,000, has an expected useful life of 10 years, a salvage value of zero, and is expected to increase net annual cash flows by $55,000. A discount rate of 9% 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.)

Answer 1

Compute the Net present value of the project as follows: Project-A: Present value Present value | 0 S -4,00,000 1 S 70,000 2 S 70,000 3 S 70,000 4 S 70,000 5 S 70,000 6 S 70,000 7 S 70,000 8S 70,000 9 S 70,000 10 S 70,000 Year Cash flow l factor@9%|ofcashfloy 1.00000 S -4,00,000 0.91743 S 64,220 58,918 0.77218 S 54,053 0.70843 S49,590 0.64993 S 45,495 0.59627 S 41,739 0.54703 S 38,292 0.50187 S35,131 0.84168 S 0.46043 S32,230 0.42241 S 29,569 49,236 Net Present Value Thus, the amount of net present value of Project-A is $49,236 Project-B: Present value Present value Year cash flow O S -3,10,000 1 S 55.000 2 S 55,000 3 S 55,000 4 S 55,000 5S55,000 6 S 55,000 7 S 55,000 8S 55,000 9 S 55,000 10 S 55,000 l factor@9%|ofcashfloy 1.00000 S -3.10,000 50.459 0.84168 S 46,292 0.91743 S 0.77218 S42,470 0.70843 S 38,963 0.64993 S 35,746 0.59627 S 32,795 0.54703 S 30,087 0.50187 S 27,603 0.46043 S25,324 0.42241| S 23,233 S 42,971 Net Present Value

Thus, the amount of net present value of Project-B is $42,971 Profitability Index: Profitability Index- Present value of future cash flows Initial investm ent Compute the Profitabilitv index of the proiect as follows: Project-A: Present value Present value Year Cash fwfactor%of cash flow 1 S 70,000 2 S 70,000 3 S 70,000 4 S 70,000 5 70,000 6 S 70,000 71$ 70,000 8 S 70,000 9 S 70,000 10 S 70,000 0.91743 S 64,220 0.84168 S 0.77218 S 0.70843 S49,590 0.64993 S 45,495 0.59627| S 41,739 0.54703 S38,292 0.50187 S 0.46043 S32,230 0.42241 S 29,569 58,918 54,053 35,131 Present value of future cash flows S 4,49,236 Profitability Index- Present value of future cash flows Initial investm ent S449,236 S400,000 Thus, the amount of profitability index of Project-A is 1.12

Project-B: Present value Present value | 1 S 55.000 2 S 55,000 3 55,000 4 S 55,000 5S55,000 6 S 55,000 7 S 55,000 8S 55,000 9 S 55,000 10 S 55,000 Year Cash flow l factor@%-ofcashfloy 50,459 46.292 0.77218 S 42,470 0.70843 S 38,963 0.64993| S35,746 0.59627 32,795 0.54703 S 30,087 0.50187 S27,603 0.46043 S 25,324 0.42241 S 23,233 Present value of future cash flows S 3,52,971 0.91743 S 0.84168 S Profitability Index- Present value of future cash flows Initial investment S352,971 $310,000 Thus, the amount of profitability index of Project-B is 114