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 $514,803, has an expected useful life of 15 years, a salvage value of zero, and is expected to increase net annual cash flows by $70,600. Project B will cost $326,840, has an expected useful life of 15 years, a salvage value of zero, and is expected to increase net annual cash flows by $46,600. A discount rate of 9% is appropriate for both projects. (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.) Profitability index Which project should be accepted?

Explanation / Answer

1) Working for Net present value Annuity factor at 9% for 15 years 8.06063 Project A Net Present value can be calculated as Amount Annuity Factor Present Value Cash Inflow ( year 1 to year 15) 70600 8.06063 569080 Cash Out flow 514803 1 514803 Net Present value for project A 54277 Project B Net Present value can be calculated as Amount Annuity Factor Present Value Cash Inflow ( year 1 to year 15) 46600 8.06063 375625 Cash Out flow 326840 1 326840 Net Present value for project B 48785 2) Profitability Index can be calculated as = Present Value of cash inflows / initial investment Project A = 569080 / 514803 = 1.11 Project B = 375625 / 326840 = 1.15 Project A Project B Net present Value 54277 48785 Profitability Index 1.11 1.15 Project B should be accepted as it has positive NPV and also higher Profitability Index

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