MUST SHOW ALL WORK Midtown Shopping Center is trying to decide between the follo
ID: 2491348 • Letter: M
Question
MUST SHOW ALL WORK
Midtown Shopping Center is trying to decide between the following two investments:
Equipment #1 Equipment #2
Initial outlay $5,000 Initial outlay $8,000
Annual cash inflow $1,800 Annual cash inflow $2,900
Estimated useful life 4 years Estimated useful life 4 years
Residual value $ 500 Residual value $ 200
Assume the cost of capital is 12%.
Required: MUST SHOW ALL WORK
Calculate the NPV and profitability index for each equipment. Based on your calculations, which equipment should they purchase?
Explanation / Answer
Equipment 1
Profitability index = 1+ (Net present value / initial investment required)
Equipment 2
Profitability index = 1+ (Net present value / initial investment required)
Net present value of equipment 1 is less than equipment 2, so equipment 2 but Profitibility index of equipment 2 is less than equipment 1 so equipment 1 should be purchased.
Year Cash Flow PV Factor = 1/(1+r)^N Present Value = Cash Flow * PV factor 0 ($5,000) 1.0000 ($5,000.00) 1 $1,800 0.8929 $1,607.14 2 $1,800 0.7972 $1,434.95 3 $1,800 0.7118 $1,281.20 4 $2,300 0.6355 $1,461.69 Sum of Present Value of the Cash Flows $5,784.99 Less: Amount invested ($5,000.00) Net Present value = Total PV - Intial Investment $784.99Related Questions
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