McKnight Company is considering two different, mutually exclusive capital expend
ID: 2486204 • Letter: M
Question
McKnight Company is considering two different, mutually exclusive capital expenditure proposals. Project A will cost $532,898, has an expected useful life of 15 years, a salvage value of zero, and is expected to increase net annual cash flows by $72,300. Project B will cost $365,983, has an expected useful life of 15 years, a salvage value of zero, and is expected to increase net annual cash flows by $50,800. 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.)
Which project should be accepted based on Net Present Value?
Which project should be accepted based on profitability index?
Explanation / Answer
NPV = {Net Period Cash Flow*Sum of PVF of I for n period} - Initial Investment Alternative A NPV = {Net Period Cash Flow*Sum of PVF of 9% for 15 period} - Initial Investment NPV = {$73200* 8.06069} - $532898 NPV= $590042-$532898 NPV= 57144 $ Profitability Index = PV of Future Cash Flows/Inintial Investment Profitability Index = {$73200* 8.06069}/ $532898 Profitability Index = $590042/ $532898 Profitability Index = 1.11 Alternative B NPV = {Net Period Cash Flow*Sum of PVF of 9% for 15 period} - Initial Investment NPV = {$50800* 8.06069} - $365983 NPV= $409483 - $365983 NPV= 43500 $ Profitability Index = PV of Future Cash Flows/Inintial Investment Profitability Index = {$50800* 8.06069}/ $365983 Profitability Index = $409483/ $365983 Profitability Index = 1.12 Basis NPV PI Alternative A $57,144 1.11 Alternative B $43,500 1.12 Higher the better Alternative A Alternative B