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Survey of Accounting (Accounting I)

8th Edition
Carl Warren
ISBN: 9781305961883

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BuyFindarrow_forward

Survey of Accounting (Accounting I)

8th Edition
Carl Warren
ISBN: 9781305961883
Textbook Problem

Net present value method, present value index, and analysis

Donahue Industries Inc. wishes to evaluate three capital investment projects by using thenet present value method. Relevant data related to the projects are summarized as follows:

Instructions

Which project offers the largest amount of present value per dollar of investment? Explain.

To determine

Concept Introduction:

NPV:

Net present value (NPV) is the method to evaluate the project feasibility. This method calculates the present value of cash inflows and outflows, and then calculates the net present value of the investment. A project should be accepted if it has a positive NPV. The formula to calculate the NPV is as follows:

  NPV = Present value of cash inflows  Present value of cash out flows

To Identify:

The project which is offering the highest amount of present value per dollar of investment

Explanation

The Present value Index for each project is prepared as follows:

    Product Line ExpansionAmount PVF (20%) PV
    A B =A*B
    Annual Net Cash Flows
    Year 1 $ 4,200,000 0.83333 $ 3,500,000
    Year 2 $ 3,600,000 0.69444 $ 2,500,000
    Year 3 $ 3,000,000 0.57870 $ 1,736,111
    Present Value of Cash Inflow (A) $ 7,736,111
    Investment (B) $ 4,000,000 1.00000 $ 4,000,000
    Present Value Index (A/B) 1.93
    Distribution FacilitiesAmount PVF (20%) PV
    A B =A*B
    Annual Net Cash Flows
    Year 1 $ 1,000,000 0.83333 $ 833,333
    Year 2 $ 1,200,000 0...

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