Magenta Company is considering two new projects, each requiring an equipment investment of $90,000. Each project will last for three years and produce the following cash inflows:
|
Year
|
Cool
|
Hot
|
|
1
|
$38,000
|
$42,000
|
|
2
|
$42,000
|
$42,000
|
|
3
|
$42,000
|
$42,000
|
|
$122,000
|
$126,000
|
The equipment will have no salvage value at the end of its three-year life. Magenta Company uses straight-line depreciation, and requires a minimum rate of return of 12%.
Present value data are as follows:
Present Value of 1 Present Value of an Annuity of 1
Period 12% Period 12%
1 .89286 1 .89286
2 .79719 2 1.69005
3 .71178 3 2.40183
Instructions
(a) Compute the net present value of each project.
(b) Compute the profitability index of each project.
(c) Which project should be selected? Why?