Equipment A has a cost of ₹ 75,000 and net cash flow of ₹ 20,000 per year for six years. A substitute equipment B would cost ₹ 50,000 and generate net cash flow of ₹ 14,000 per year for six years. The required rate of re

Calculation of Net Present Value (NPV) and Profitability Index (PI) Required Rate of Return = 11% Present Value Annuity Factor (PVAF) for 6 years at 11% = 0.901 + 0.812 + 0.731 + 0.659 + 0.593 + 0.535 = 4.231 Equipment A: Initial Cost = ₹ 75,000 Annual Net Cash Flow = ₹ 20,000 for 6 years Present Value of Cash Inflows = Annual Net Cash Flow × PVAF (6 years, 11%) = ₹ 20,000 × 4.231 = ₹ 84,620 Net Present Value (NPV) = Present Value of Cash Inflows - Initial Cost = ₹ 84,620 - ₹ 75,000 = ₹ 9,620 Profitability Index (PI) = Present Value of Cash Inflows / Initial Cost = ₹ 84,620 / ₹ 75,000 = 1.128 Equipment B: Initial Cost = ₹ 50,000 Annual Net Cash Flow = ₹ 14,000 for 6 years Present Value of Cash Inflows = Annual Net Cash Flow × PVAF (6 years, 11%) = ₹ 14,000 × 4.231 = ₹ 59,234 Net Present Value (NPV) = Present Value of Cash Inflows - Initial Cost = ₹ 59,234 - ₹ 50,000 = ₹ 9,234 Profitability Index (PI) = Present Value of Cash Inflows / Initial Cost = ₹ 59,234 / ₹ 50,000 = 1.185 Decision: Which equipment should be accepted and why? As per the NPV criterion, Project A (NPV = ₹ 9,620) is preferred over Project B (NPV = ₹ 9,234) because it yields a higher absolute net present value, indicating a greater increase in shareholder wealth. However, as per the PI technique, Project B (PI = 1.185) is preferred over Project A (PI = 1.128) because it generates a higher return per rupee of investment. Conclusion: The NPV decision should generally be preferred unless there is capital rationing. If the firm has funds of ₹ 75,000 to invest (sufficient for Project A), then Project A should be adopted. This will result in an increase in shareholders' wealth to the extent of ₹ 9,620, which is higher than the wealth increase from Project B (₹ 9,234).