Question

Bramble Company is considering two different, mutually exclusive capital expenditure proposals. Project A will cost $401,000, has an expected useful life of 11 years and a salvage value of zero, and is expected to increase net annual cash flows by $70,000. Project B will cost $260,000, has an expected useful life of 11 years and a salvage value of zero, and is expected to increase net annual cash flows by $48,000. A discount rate of 10% is appropriate for both projects. Click here to view the factor table. Calculate 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 e.g. -45 or parentheses e.g. (45). Round present value answers to O decimal places, e.g. 125 and profitability index answers to 2 decimal places, e.g. 15.52. For calculation purposes, use 5 decimal places as displayed in the factor table provided, e.g. 1.25124.)

Answer 1

Project A has a higher net present value and profitability index than Project B. Therefore, Project A is the more attractive investment.

How to solve this

Project A

Present Value of Annual Cash Flows

Year Cash Flow Factor PV of Cash Flow

1 70,000 0.9091 63,637

2 70,000 0.8264 58,848

3 70,000 0.7513 52,591

4 70,000 0.6830 47,810

5 70,000 0.6209 43,463

6 70,000 0.5645 40,515

7 70,000 0.5132 36,024

8 70,000 0.4665 32,655

9 70,000 0.4241 29,697

10 70,000 0.3855 27,995

11 70,000 0.3506 24,542

Total Present Value of Cash Flows = $428,353

Net Present Value

Net Present Value = Present Value of Cash Flows - Initial Outlay

Net Present Value = $428,353 - $401,000 = $27,353

Profitability Index

Profitability Index = (Present Value of Cash Flows) / (Initial Outlay)

Profitability Index = $428,353 / $401,000 = 1.070

Project B

Present Value of Annual Cash Flows

Year Cash Flow Factor PV of Cash Flow

1 48,000 0.9091 43,944

2 48,000 0.8264 40,252

3 48,000 0.7513 36,062

4 48,000 0.6830 32,384

5 48,000 0.6209 28,315

6 48,000 0.5645 25,326

7 48,000 0.5132 22,821

8 48,000 0.4665 20,882

9 48,000 0.4241 19,076

10 48,000 0.3855 17,604

11 48,000 0.3506 16,833

Total Present Value of Cash Flows = $371,826

Net Present Value

Net Present Value = Present Value of Cash Flows - Initial Outlay

Net Present Value = $371,826 - $260,000 = $111,826

Profitability Index

Profitability Index = (Present Value of Cash Flows) / (Initial Outlay)

Profitability Index = $371,826 / $260,000 = 1.437

Conclusion

Project A has a higher net present value and profitability index than Project B. Therefore, Project A is the more attractive investment.