McKnight Company is considering two different, mutually exclusive capital expend
ID: 2485676 • Letter: M
Question
McKnight Company is considering two different, mutually exclusive capital expenditure proposals. Project A will cost $495,912, has an expected useful life of 12 years, a salvage value of zero, and is expected to increase net annual cash flows by $72,400. Project B will cost $334,604, has an expected useful life of 12 years, a salvage value of zero, and is expected to increase net annual cash flows by $50,000. A discount rate of 8% 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.)
Which project should be accepted based on Net Present Value?
Which project should be accepted based on profitability index?
Explanation / Answer
Project A
year
CashFlow
PV Factor@ 8%
PV
0
(495,912)
1.0000
(495,912.00)
1
72,400
0.9259
67,037.04
2
72,400
0.8573
62,071.33
3
72,400
0.7938
57,473.45
4
72,400
0.7350
53,216.16
5
72,400
0.6806
49,274.22
6
72,400
0.6302
45,624.28
7
72,400
0.5835
42,244.70
8
72,400
0.5403
39,115.47
9
72,400
0.5002
36,218.03
10
72,400
0.4632
33,535.21
11
72,400
0.4289
31,051.12
12
72,400
0.3971
28,751.04
NPV
49,700.05
Profitability Index= NPV+ Initial Investment/ Initial Investment
=$49,700+$495,912/495,912
=$545,612/$495,912
=1.10
Project B
year
CashFlow
PV Factor@ 8%
PV
0
(334,604)
1.0000
(334,604.00)
1
50,000
0.9259
46,296.30
2
50,000
0.8573
42,866.94
3
50,000
0.7938
39,691.61
4
50,000
0.7350
36,751.49
5
50,000
0.6806
34,029.16
6
50,000
0.6302
31,508.48
7
50,000
0.5835
29,174.52
8
50,000
0.5403
27,013.44
9
50,000
0.5002
25,012.45
10
50,000
0.4632
23,159.67
11
50,000
0.4289
21,444.14
12
50,000
0.3971
19,855.69
NPV
42,199.90
Profitability Index= NPV+ Initial Investment/ Initial Investment
=$42,200+ $334,604/$334,604
=$376,804/$334,604
=1.13
Net present value - Project A=$49,700
Profitability index - Project A=1.10
Net present value - Project B=$42,200
Profitability index - Project B=1.13
Which project should be accepted based on Net Present Value?
As per NPV Project A should be accepted as its NPV is higher than Project B’s NPV
Which project should be accepted based on profitability index?
As per PI Project B should be accepted as its PI is higher than Project A’s PI
Project A
year
CashFlow
PV Factor@ 8%
PV
0
(495,912)
1.0000
(495,912.00)
1
72,400
0.9259
67,037.04
2
72,400
0.8573
62,071.33
3
72,400
0.7938
57,473.45
4
72,400
0.7350
53,216.16
5
72,400
0.6806
49,274.22
6
72,400
0.6302
45,624.28
7
72,400
0.5835
42,244.70
8
72,400
0.5403
39,115.47
9
72,400
0.5002
36,218.03
10
72,400
0.4632
33,535.21
11
72,400
0.4289
31,051.12
12
72,400
0.3971
28,751.04
NPV
49,700.05