Brief Exercise 12-5 McKnight Company is considering two different, mutually excl

Question

Brief Exercise 12-5

McKnight Company is considering two different, mutually exclusive capital expenditure proposals. Project A will cost $460,910, has an expected useful life of 11 years, a salvage value of zero, and is expected to increase net annual cash flows by $68,000. Project B will cost $297,440, has an expected useful life of 11 years, a salvage value of zero, and is expected to increase net annual cash flows by $45,000. A discount rate of 7% 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.)

Which project should be accepted based on Net Present Value?

Which project should be accepted based on profitability index?

Net present value - Project A $

Profitability index - Project A

Net present value - Project B $

Profitability index - Project B

Explanation / Answer

NPV=PV cfat - PV c

Present value of future cash inflows after taxs - present value of investment

Profitability index= sim of present value of cash inflows÷sum of present value of cash outflows

So A, B project annual cah inflows $68000, $45000

ccost of both projects are $ 460910, $297440

pv annuity factor@ 7% 11 years value is 15.7836

A project 15.7836×68000 minus 1.000×460910= 6123748.

B project 15.7836×45000 minus 1.000×297440=412822 so comparison of both projects npv s A project is the best project.

A project profitability index is 1073284.8÷460910= 2.328.

B project profitability index is 710262÷297440 = 2.387 so both projects are acceptable because more than one index is acceptable. So both are acceptable projects.

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