Brief Exercise 24-5 Brief Exercise 24-5 McKnight Company is considering two diff

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Brief Exercise 24-5

Brief Exercise 24-5

McKnight 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 $310,000, has an expected useful life of 10 years, a salvage value of zero, and is expected to increase net annual cash flows by $55,000. A discount rate of 9% is appropriate for both projects. Click here to view PV table.

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. For calculation purposes, use 5 decimal places as displayed in the factor table provided.)
Net present value - Project A $

Profitability index - Project A

Net present value - Project B $

Profitability index - Project B

Which project should be accepted based on Net Present Value?

Project AProject B

should be accepted.
Which project should be accepted based on profitability index?

Project BProject A

should be accepted.

Explanation / Answer

On the basis of Net present value we should accept Project A because it has higher net present value than the Project B.

On the basis of Profitability index we should accept Project B because it has higher profitability index than the Project A.

Particulars Project A Project B Present value of cash inflow=
Annual cash inflow x Cumulative pvf for 10 year @9% $70,000 x 6.41766 = $449,236 $55,000 x 6.41766 = $352,971 Less: Initial cash ourflow $400,000 $310,000 Net present value $49,236 $42,971 Profitability index = Present value of cash inflow / Present value of cash outflow 1.12 1.14

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