Question

Finch Delivery is a small company that transports business packages between New York and Chicago. It operates a fleet of small vans that moves packages to and from a central depot within each city and uses a common carrier to deliver the packages between the depots in the two cities. Finch Delivery recently acquired approximately $6.3 million of cash capital from its owners, and its president, George Hay, is trying to identify the most profitable way to invest these funds. Todd Payne, the company's operations manager, believes that the money should be used to expand the fleet of city vans at a cost of $690,000. He argues that more vans would enable the company to expand its services into new markets, thereby increasing the revenue base. More specifically, he expects cash inflows to increase by $310,000 per year. The additional vans are expected to have an average useful life of four years and a combined salvage value of $96,000. Operating the vans will require additional working capital of $37,000, which will be recovered at the end of the fourth year. In contrast, Oscar Vance, the company's chief accountant, believes that the funds should be used to purchase large trucks to deliver the packages between the depots in the two cities. The conversion process would produce continuing improvement in operating savings and reduce cash outflows as follows: Year 1 Year 2 Year 3 Year 4 $164,000 $311,000 $393,000 $439,000 The large trucks are expected to cost $770,000 and to have a four-year useful life and a $86,000 salvage value. In addition to the purchase price of the trucks, up-front training costs are expected to amount to $11,000. Finch Delivery's management has established a 10 percent desired rate of return. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.) Required a.&b. Determine the net present value and present value index for each investment alternative. (Enter answers in whole dollar, not in million. Negative amounts should be indicated by a minus sign. Round your intermediate calculations and final answers to 2 decimal places.)

Answer 1

Solution:

Calculation of Net Present Value and Present Value Index for Purchase of City Vans

	$
Cost of Fleet of City Vans	690,000.00
Additional Working Capital	37,000.00
Total Initial Investment	727,000.00

Year	Increase in Cash Inflows $	Discounting Factor @ 10%	Present Value of Increase in Cash Inflows $
1	3,10,000.00	0.9091	2,81,818.18
2	3,10,000.00	0.8264	2,56,198.35
3	3,10,000.00	0.7513	2,32,907.59
4	4,43,000.00	0.6830	3,02,574.96
		Total Present Value of Increase in Cash Inflows $	10,73,499.08

Note: Cash Inflows for the fourth year also includes Scrap value of the City vans $96,000 and recovery of working capital $37,000.

Net Present Value = Total Present Value of Increase in Cash Inflows $ - Total Initial Investment $

                                  = $1,073,499.08 - $727,000.00 = $346,499.08

Present Value Index = Net Present Value / Total Initial Investment

                                  = $346,499.08 / $727,000.00 = 0.4766

Calculation of Net Present Value and Present Value Index for Purchase of Large Trucks

	$
Cost of Large Trucks	7,70,000.00
Additional Training Cost	11,000.00
Total Initial Investment	7,81,000.00

Year	Savings in Cash Inflows $	Discounting Factor @ 10%	Present Value of Increase in Cash Inflows $
1	1,64,000.00	0.9091	1,49,090.91
2	3,11,000.00	0.8264	2,57,024.79
3	3,93,000.00	0.7513	2,95,266.72
4	5,25,000.00	0.6830	3,58,582.06
		Total Present Value of savings in Cash Inflows $	10,59,964.48

Note: Cash Inflows for the fourth year also includes Scrap value of the Large Vans $86,000

Net Present Value = Total Present Value of Increase in Cash Inflows $ - Total Initial Investment $

                                  = $1,059,964.48 - $7,81,000.00 = $2,78,964.48

Present Value Index = Net Present Value / Total Initial Investment

                                  = $278,964.48 / 781,000.00 = 0.3572

		Purchase of City Vans	Purchase of Trucks
a	Net Present Value (NPV)	$346,499.08	$278,964.48
b	Present Value Index (PVI)	0.4766	0.3572

It is recommended that Finch Delivery should go for purchase of city vans.