Bill Zimmerman is evaluating two new business opportunities. Each of the opportu

Question

Bill Zimmerman is evaluating two new business opportunities. Each of the opportunities shown below has a ten-year life. Bill uses a 11% discount rate.

Option 1 Equipment purchase and installation $81,980

Annual Cash flow $28,600

Equipment overhaul in year 3 $4,950

Option 2 Equipment purchase and installation $70,200

Annual cash flow $30,840

Equipment overhaul in year 5 - $6,000

a) Calculate the Net presnet value of the two oppourtnites (Round present value factor calculations to 4 decimal places, e.g. 1.2514 and the final answers to 0 decimal places, e.g. 59,991.)

b) Calculate the profitability index of the two opportunities (Round answers to 2 decimal places, e.g. 15.25.)

c) Which option should Bill choose?

Explanation / Answer

Calculation of NPV

Option - 1

NPV = - 81980 + 28600 * [ 1 - (1.11)-10 ] / 0.11 - 4950 / (1.11)3 = - 81980 + 168432 - 3619.40 =  82832

Option - 2

NPV = - 70200 + 30840 * [ 1 - (1.11)-10 ] / 0.11 - 6000 / (1.11)5 = - 70200 + 181623.92 - 3560.71 =  107863

Question - b

Profitability index = 1 + NPV / Investment  

Option - 1 = 1 + 82832 / 81980 =  2.0104 or 201.04 %

Option - 2 = 1 + 107863 / 70200 = 2.5365 or 253.65 %

Question - c

Option - 2 with higher PROFITABILITY INDEX should be selected

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