Beacon Company is considering two different, mutually exclusive capital expendit

Question

Beacon 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 $280,000, has an expected useful life of 10 years, a salvage value of zero, and is expected to increase net annual cash flows by $50,000. A discount rate of 9% is appropriate for both projects.

Click here to view the factor table.

(For calculation purposes, use 5 decimal places as displayed in the factor table provided.)

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.)

Which project should be accepted?

Project A Project B Net present value $ $ Profitability index

Explanation / Answer

NPV of both the projects is calculated as under:

Profitability index of both projects is prepared as under:

Project A should be accepted as it is having the more NPV.

Project A Year 0 Year 1-Year 10 Cash Outflow ($4,00,000) Cash Inflow $70,000 Net Cash Flow ($4,00,000) $70,000 Life 10 years Required Rate of Return is 9% Present Value factor 1 6.41766 Present Value of Cash outflow -4,00,000 4,00,000 Present Value of Cash inflow 4,49,236 4,49,236 Net Present value -4,00,000 4,49,236 49,236 Project A Year 0 Year 1-Year 10 Cash Outflow ($2,80,000) Cash Inflow $50,000 Net Cash Flow ($2,80,000) $50,000 Life 10 years Required Rate of Return is 9% Present Value factor 1 6.41766 Present Value of Cash outflow -2,80,000 2,80,000 Present Value of Cash inflow 3,20,883 3,20,883 Net Present value -2,80,000 3,20,883 40,883

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