Beacon Company is considering two different, mutually exclusive capital expendit
ID: 2471712 • Letter: B
Question
Beacon Company is considering two different, mutually exclusive capital expenditure proposals. Project A will cost $502,821, has an expected useful life of 14 years, a salvage value of zero, and is expected to increase net annual cash flows by $71,600. Project B will cost $344,174, has an expected useful life of 14 years, a salvage value of zero, and is expected to increase net annual cash flows by $50,400. A discount rate of 9% is appropriate for both projects.
a. 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. Round Discount Factor to 5 decimal places, e.g. 0.17986.)
Net present value - Project A: $ _____
Profitability index - Project A: _____
Net present value - Project B: $ _____
Profitability index - Project B: _____
b. Which project should be accepted? (A or B)
Explanation / Answer
NPV of Project A
Year
Cash flow or Incremental cash flow
PVF @9%
Discounted cash flow or Incremental cash flow
0
(502,821)
1.0000
(502,821)
1
71,600
0.9174
65,688
2
71,600
0.8417
60,264
3
71,600
0.7722
55,288
4
71,600
0.7084
50,723
5
71,600
0.6499
46,535
6
71,600
0.5963
42,693
7
71,600
0.5470
39,168
8
71,600
0.5019
35,934
9
71,600
0.4604
32,967
10
71,600
0.4224
30,245
11
71,600
0.3875
27,747
12
71,600
0.3555
25,456
13
71,600
0.3262
23,354
14
71,600
0.2992
21,426
NPV of project A
54,667.37
NPV of Project B
Year
Cash flow or Incremental cash flow
PVF @9%
Discounted cash flow or Incremental cash flow
0
(344,174)
1.0000
(344,174)
1
50,400
0.9174
46,239
2
50,400
0.8417
42,421
3
50,400
0.7722
38,918
4
50,400
0.7084
35,705
5
50,400
0.6499
32,757
6
50,400
0.5963
30,052
7
50,400
0.5470
27,571
8
50,400
0.5019
25,294
9
50,400
0.4604
23,206
10
50,400
0.4224
21,290
11
50,400
0.3875
19,532
12
50,400
0.3555
17,919
13
50,400
0.3262
16,439
14
50,400
0.2992
15,082
NPV
48,247.98
Profitability Index:
Profitability index is an investment appraisal technique calculated by dividing the present value of future cash flows of a project by the initial investment required for the project.
Formula:
Profitability Index = Present Value of Future Cash Flows / Initial Investment Required
Profitability Index of Project A:
Present Value of Future Cash Flows = $392,422
Initial Investment Required = $344,174
Profitability Index = $392,422 / $344,174
Profitability Index = 1.14
Profitability Index of Project B:
Present Value of Future Cash Flows = $557,488
Initial Investment Required = $502,821
Profitability Index = $557,488 / $502,821
Profitability Index = 1.12
Decision Rule:
Accept a project if the NPV is higher positive value and profitability index is greater than 1. So Project A should be accepted.
NPV of Project A
Year
Cash flow or Incremental cash flow
PVF @9%
Discounted cash flow or Incremental cash flow
0
(502,821)
1.0000
(502,821)
1
71,600
0.9174
65,688
2
71,600
0.8417
60,264
3
71,600
0.7722
55,288
4
71,600
0.7084
50,723
5
71,600
0.6499
46,535
6
71,600
0.5963
42,693
7
71,600
0.5470
39,168
8
71,600
0.5019
35,934
9
71,600
0.4604
32,967
10
71,600
0.4224
30,245
11
71,600
0.3875
27,747
12
71,600
0.3555
25,456
13
71,600
0.3262
23,354
14
71,600
0.2992
21,426
NPV of project A
54,667.37
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