a. Compute the net present value and profitability index of each project. (If th

ID: 2465269 • Letter: A

Question

a. 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. Round Discount Factor to 5 decimal places, e.g. 0.17986.)

b. Which project should be accepted?

Net present value - Project A $___________________ Profitability index - Project A ____________________ Net present value - Project B $___________________ Profitability index - Project B ____________________

Explanation / Answer

Solution:

Calculation of NPV and Profitability Index

Project A

Project B

Cost of Project (Present Value of Cash Outflow)

$473,399

$301,426

Expected Useful life

13 Years

Salvage Value

Increase in Net Annual Cash Flow

$74,500

$49,300

PVIFA (10%, 13)

7.10336

Present Value of Cash Flow

(Net Annual Cash Flow x PVIFA (10%, 13)

$529,200

$350,196

Net Present Value

(Present Value of Cash Flow - Cost of Project)

$55,801

$48,770

Profitability Index

(Present Value of Cash Flow / Present Value of Cash Outflow)

1.12

1.16

Which project should be accepted? ----- Project A

As per Net Present Value method, project A should be accepted since the NPV is higher in this project but as per Profitability Index Project B should be accepted because Project B has higher Profitability Index.

Net Present Value is a better measure of profitability – hence Project A should be selected if availability of funds for Cost of Project is not a problem.