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 $477,608, has an expected useful life of 14 years, a salvage value of zero, and is expected to increase net annual cash flows by $72,100. Project B will cost $286,322, has an expected useful life of 14 years, a salvage value of zero, and is expected to increase net annual cash flows by $45,700. A discount rate of 10% is appropriate for both projects.

TABLE 1 Future Value of 1 Periods 4% 5% 6% 170 790 1.00000 1.00000 1.00000 1.00000 1.00000 1.00000 1.00000 1.00000 1.00000 1.00000 1.04000 1.05000 1.06000 1.07000 1.08000 1.09000 1.10000 1.11000 .12000 1.15000 1.08160 1.10250 .12360 1.14490 1.16640 1.18810 1.21000 1.23210 1.25440 .32250 1.12486 .15763 1.19102 1.22504 1.25971 1.29503 .33100 1.36763 1.40493 1.52088 1.16986 1.21551 1.26248 1.31080 1.36049 1.41158 1.46410 1.51807 1.57352 1.74901 1.21665 1.27628 1.33823 1.40255 1.46933 1.53862 1.61051 1.68506 1.76234 2.01136 1.26532 1.34010 1.41852 1.50073 1.58687 1.67710 1.77156 1.87041 1.97382 2.31306 1.31593 1.40710 1.50363 1.60578 1.71382 1.82804 1.94872 2.07616 2.21068 2.66002 1.368571.47746 1.59385 1.71819 1.85093 1.99256 2.14359 2.30454 2.47596 3.05902 1.42331 .55133 1.68948 1.83846 1.99900 2.17189 2.35795 2.55803 2.77308 3.51788 1.48024 1.62889 1.79085 1.96715 2.15892 2.36736 2.59374 2.83942 3.10585 4.04556 1.539451.71034 1.89830 2.10485 2.33164 2.58043 2.85312 3.15176 3.47855 4.65239 1.60103 1.79586 2.01220 2.25219 2.51817 2.81267 3.13843 3.49845 3.89598 5.35025 1.665071.88565 2.13293 2.40985 2.71962 3.0658 3.45227 3.88328 4.36349 6.15279 1.73168 1.97993 2.26090 2.57853 2.93719 3.34173 3.79750 4.31044 4.88711 7.07571 1.800942.07893 2.39656 2.75903 3.17217 3.64248 4.17725 4.78459 5.47357 8.13706 1.87298 2.18287 2.54035 2.95216 3.42594 3.97031 4.59497 5.31089 6.13039 9.35762 1.94790 2.29202 2.69277 3.15882 3.70002 4.32763 5.05447 5.89509 6.86604 10.76126 18 2.02582 2.40662 2.85434 3.37993 3.99602 4.71712 5.55992 6.54355 7.68997 12.37545 19 2.10685 2.52695 3.02560 3.61653 4.31570 5.14166 6.11591 7.26334 8.61276 14.23177 2.19112 2.65330 3.20714 3.86968 4.66096 5.60441 6.72750 8.06231 9.64629 16.36654 2 10 12 13 14 15 16 17 20

Explanation / Answer

Net present value of project A

= (Net annual cash flows x Present value of an annuity of $1 per period at 10% for 14 periods) - Initial investment

= ($72,100 x 7.36669) - $477,608

= $53,530.35

Net present value of project B

= (Net annual cash flows x Present value of an annuity of $1 per period at 10% for 14 periods) - Initial investment

= ($45,700 x 7.36669) - $286,322

= $50,335.73

Profitability index for Project A

= 1 + (Net present value / Initial investment)

= 1 + (53,530.35 / 477,608)

= 1.11

Profitability index for Project B

= 1 + (Net present value / Initial investment)

= 1 + (50,335.73 / 286,322)

= 1.17

The net present value of Project A is higher than Project B and the profitability index for the two projects are almost equal. Therefore, Project A should be accepted.

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