Planning and Capital Investment



Answer BE10-51

Net Present Value1

Profitability Index3

Suggested Option4

Post Audit5

Answer BE10-85

Internal rate of return6

Annual Rate of Return7

Suggestion7

Answer P10-3A8

Net Present Value8

Profitability Index9

Internal rate of Return9

Suggestion10

Reference12

Planning and Capital Investment

Answer BE10-5

Company is going through two mutually exclusive capital expenditures which are proposed as a potential investment. This effort will show that which option is better for the organization and in which one of these, the invested amount is generating better profits. This will help the Harry Company in taking the appropriate decision for increasing the profitability of the organization. For doing so, Net present value and profitability index are calculated and interpreted below:

Net Present Value

Wisdom of an invested in measured by calculating the NPV. It is a widely used tool and it's also considered as a better option that most of the other methods of capital budgeting. NPV basically enable the management to take decision by keeping the time value of money in view. A positive NPV is good for the organization and a higher NPV is even more desirable (www.credoreference.com.).

The table below is illustrating the net present value NPV of the first proposed project:

Years

Project A

Cash flow

PV factor

NPV

0

($ 395,000)

1

($ 395,000)

1

$ 70,000

0.917431

$ 64,220

2

$ 70,000

0.841680

$ 58,918

3

$ 70,000

0.772183

$ 54,053

4

$ 70,000

0.708425

$ 49,590

5

$ 70,000

0.649931

$ 45,495

6

$ 70,000

0.596267

$ 41,739

7

$ 70,000

0.547034

$ 38,292

8

$ 70,000

0.501866

$ 35,131

9

$ 70,000

0.460428

$ 32,230

10

$ 70,000

0.422411

$ 29,569

 

$ 54,236

In the table above the present value factor is calculated by taking 1 as numerator in all ten years and keeping the 1 plus discount rate as the denominator by putting the power of each year individually. The product of PV factor and even forecasted cash flow are then kept in the third column, which are playing their parts in generating the overall NPV (Brigham & Houston, 2009) of the project A.

The table below is illustrating the net present value NPV of the second proposed project:

Years

Project B

Cash flow

PV factor

NPV

0

($ 270,000)

1

($ 270,000)

1

$ 50,000

0.91743

$ 45,872

2

$ 50,000

0.84168

$ 42,084

3

$ 50,000

0.77218

$ 38,609

4

$ 50,000

0.70843

$ 35,421

5

$ 50,000

0.64993

$ 32,497

6

$ 50,000

0.59627

$ 29,813

7

$ 50,000

0.54703

$ 27,352

8

$ 50,000

0.50187

$ 25,093

9

$ 50,000

0.46043

$ 23,021

10

$ 50,000

0.42241

$ 21,121

 

 

$ 50,883

In the table above again the present value factor is calculated by taking 1 as the numerator in all ten years and keeping the 1 plus discount rate as the denominator by putting the power of each year individually. The product of PV factor and even forecasted cash flow is then kept in the third column, which are playing their parts in generating the overall NPV of the project B.

Profitability Index

The table below along with the calculations given is illustrating the Profitability index of the first proposed project:

Years

Project A

 

Cash flow

PV factor

Profitability Index

1

$ 70,000

0.917431

$ 64,220

2

$ 70,000

0.841680

$ 58,918

3

$ 70,000

0.772183

$ 54,053

4

$ 70,000

0.708425

$ 49,590

5

$ 70,000

0.649931

$ 45,495

6

$ 70,000

0.596267

$ 41,739

7

$ 70,000

0.547034

$ 38,292

8

$ 70,000

0.501866

$ 35,131

9

$ 70,000

0.460428

$ 32,230

10

$ 70,000

0.422411

$ 29,569

 

 

 

$ 449,236

Profitability Index = Present Value of Future Cash Flows Generated by the Project / Initial Investment in the Project (www.proapod.com)

Profitability Index =?

Present Value of Future Cash Flows Generated by the Project = $ 449,236

Initial Investment in the Project = $ 395,000

Profitability Index = $ 449,236 / $ 395,000

= ...