Question

Brief Exercise 12-5 McKnight Company is considering two different, mutually exclusive capital expenditure proposals. Project A will cost $450,000, 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 $298,000, 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 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? should be accepted. Which project should be accepted based on profitability index? should be accepted.

Answer 1

Project A:
Net Annual cash flows	73500
X PV factor	6.80519
Present value of Net Annual cash flows	500181
Less: Investment cost	450000
Net present value Project A	50181
Profitability index Project A	1.11	=500181/450000
Project B:
Net Annual cash flows	50200
X PV factor	6.80519
Present value of Net Annual cash flows	341621
Less: Investment cost	298000
Net present value Project B	43621
Profitability index Project B	1.15	=341621/298000
Project A should be selected based on Net Present value
Project B should be selected based on profitability index