Magenta Company is considering two new projects, each requiring an equipment inv
ID: 2358595 • Letter: M
Question
Magenta Company is considering two new projects, each requiring an equipment investment of $90,000. Each project will last for three years and produce the following cash inflows:<?xml:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" /?>
Year
Cool
Hot
1
$38,000
$42,000
2
$42,000
$42,000
3
$42,000
$42,000
$122,000
$126,000
The equipment will have no salvage value at the end of its three-year life. Magenta Company uses straight-line depreciation, and requires a minimum rate of return of 12%.
Present value data are as follows:
Present Value of 1 Present Value of an Annuity of 1
Period 12% Period 12%
1 .89286 1 .89286
2 .79719 2 1.69005
3 .71178 3 2.40183
Instructions
(a) Compute the net present value of each project.
(b) Compute the profitability index of each project.
(c) Which project should be selected? Why?
Year
Cool
Hot
1
$38,000
$42,000
2
$42,000
$42,000
3
$42,000
$42,000
$122,000
$126,000
Explanation / Answer
a) NPV for cool = 38000/(1.12) + 42000/(1.12)^2 + 42000/(1.12)^3 - 90000 = 33928.57 + 33482.14 + 29894.77 = 7305.48 NPV for hot = 42000/1.12 + 42000/(1.12)^2 + 42000/(1.12)^3 - 90000 = 9091.19 b) PI cool = 1.08 PI hot = 1.1 C) second project should be selected because it has higher positive NPV value. :) :)
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