Beacon Company is considering two different mutually exclusive capital expenditure proposals. Project A will cost $400,000, has an expected useful life of 10 years, has a salvage value of zero, and is expected to increase net annual cash flows by $70,000. Project B will cost $280,000, has an expected useful life of 10 years, has a salvage value of zero, and is expected to increase net annual cash flows by $50,000. A discount rate of 9% is appropriate for both projects.
a. Compute the net present value and profitability index of each project.
b. Which project should be accepted?
The profitability index is the present value of cash inflows divided by the present value of cash outflows. A project is acceptable if the profitability index is more than 1.
Answer and Explanation: 1
Computation of net present value
|Project A||Project B|
|Year||PVF @ 9%||Amount...|
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fromChapter 14 / Lesson 5
The profitability index method measures the acceptability of a project through the ratio of the projected cash inflow to the initial investment. Learn about the definition and calculation of profitability index and understand how to interpret its results.