McKnight Company is considering two different, mutually exclusive capital expend
ID: 2479591 • Letter: M
Question
McKnight Company is considering two different, mutually exclusive capital expenditure proposals. Project A will cost $493,660, has an expected useful life of 12 years, a salvage value of zero, and is expected to increase net annual cash flows by $68,400. Project B will cost $330,906, has an expected useful life of 12 years, a salvage value of zero, and is expected to increase net annual cash flows by $47,000. 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 $ 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.
Explanation / Answer
Project A Cash inflow PVF @ 7% Present Value Year 0 (493,660) 1.00 -493,660 Year 1 68,400 0.935 63,925 Year 2 68,400 0.873 59,743 Year 3 68,400 0.816 55,835 Year 4 68,400 0.763 52,182 Year 5 68,400 0.713 48,768 Year 6 68,400 0.666 45,578 Year 7 68,400 0.623 42,596 Year 8 68,400 0.582 39,809 Year 9 68,400 0.544 37,205 Year 10 68,400 0.508 34,771 Year 11 68,400 0.475 32,496 Year 12 68,400 0.444 30,370 Present value of Project A 49,620 Present value of Inflows 543,280 Profitability Index = $ 543280/493660 = 1.10 Project B Cash inflow PVF @ 7% Present Value Year 0 (330,906) 1.00 -330,906 Year 1 47,000 0.935 43,925 Year 2 47,000 0.873 41,052 Year 3 47,000 0.816 38,366 Year 4 47,000 0.763 35,856 Year 5 47,000 0.713 33,510 Year 6 47,000 0.666 31,318 Year 7 47,000 0.623 29,269 Year 8 47,000 0.582 27,354 Year 9 47,000 0.544 25,565 Year 10 47,000 0.508 23,892 Year 11 47,000 0.475 22,329 Year 12 47,000 0.444 20,869 Present value of Project A 42,400 Present value of Inflows 373,306 Profitability Index = $ 373306/330906 = 1.13 Project A should be accepted on the basis of Net present value. Project B should be accepted on the basis of Profitability index as it is higher PI index.