Question

Exercise 24-10 NPV and profitability index LO P3

Following is information on two alternative investments being considered by Jolee Company. The company requires a 8% return from its investments. (PV of $1, FV of $1, PVA of $1, and FVA of $1) (Use appropriate factor(s) from the tables provided.)
  

	Project A					Project B
Initial investment		$	(181,325	)			$	(159,960	)
Expected net cash flows in year:
1			48,000					35,000
2			44,000					47,000
3			85,295					63,000
4			93,400					84,000
5			73,000					28,000

a. For each alternative project compute the net present value.
b. For each alternative project compute the profitability index. If the company can only select one project, which should it choose?

Complete this question by entering your answers in the tabs below.

Answer 1

a.Project A

Net present value is solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$181,325. It is entered with a negative sign since it is a cash outflow.
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter the interest rate.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.

Net present value at 8% required rate of return is $86,886.64.

Project B

Net present value is solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$159,960. It is entered with a negative sign since it is a cash outflow.
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter the interest rate.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.

Net present value at 8% required rate of return is $43,552.60.

b.Profitability Index= PV of future cash flows/Initial investment

Project A

PV of future cash flows is calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$181,325.
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the third cash flow cash flow, press the NPV button and enter the interest rate.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.

The present value of cash flows is $86,886.64.

Profitability Index= $86,886.64/ $181,325= 0.48.

Project B

PV of future cash flows is calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$159,960.
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the third cash flow cash flow, press the NPV button and enter the interest rate.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.

The present value of cash flows is $43,552.60.

Profitability Index= $43,552.60/ $159,960= 0.27.

The company should choose Project A since it has the higher profitability index.