Problem:
Lebar Company is considering two mutually exclusive investment alternatives. Lebar has a 10% cost of capital. Following is the cash flow information for the two alternatives (see below):
| Initial investment in equipment |
$170,000 |
$100,000 |
| Increase in annual cash flows |
$50,000 |
$30,000 |
| Life of equipment |
5 years |
5 years |
| Salvage value of equipment |
0 |
0 |
Q1. Compute the net present value for each alternative and determine which alternative is more desirable using the net value criterion.
Q2. Compute the profitability index for each alternative and determine which alternative is more desirable using the profitability index criterion.
Q3. Why do the rankings differ under the two alternatives? Which alternative would you recommend?