Question

Problem 10-16A Using present value techniques to evaluate alternative investment opportunities Swift 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. Swift Delivery recently acquired approximately $4 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 $900,000. 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 $325,000 per year. The additional vans are expected to have an average useful life of four years and a combined salvage value of $100,000. Operating the vans will require additional working capital of $50,000, 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 $175,000 $375,000 $450,000 $500,000 The large trucks are expected to cost $1,000,000 and to have a four-year useful life and a $81,250 salvage value. In addition to the purchase price of the trucks, up-front training costs are expected to amount to $20,000. Swift Delivery's management has established a 10 percent desired rate of return. Page 471 Required Round your computations to two decimal points. a. Determine the net present value of the two investment alternatives. b. Calculate the present value index for each alternative. c. Indicate which investment alternative you would recommend. Explain your choice.

Answer 1

A)

Alternative -1
Item	Years	Amount of Cash Flow	Table Value @10%	Present Value
Annual Cash Inflow	1-4	$325,000	3.170	$1,030,250
Salvage Value	4	$100,000	0.683	$68,300
Working Capital Recovery	4	$50,000	0.683	$34,150
Total Cash Inflow				$1,132,700
Initial Investment	Now	($900,000)	1	($900,000)
Working Capital Increase	Now	($50,000)	1	($50,000)
Net Present Value				$182,700

Alternative -2
Cash Inflow	Amount of Cash Flow	Table Value @10%	Present Value
Year 1	$175,000	0.909	$159,075
Year 2	$375,000	0.826	$309,750
Year 3	$450,000	0.751	$337,950
Year 4	$500,000	0.683	$341,500
Salvage Value @ Year 4	$81,250	0.683	$55,494
Total Cash Inflow			$1,203,769
Cost of Trucks	($1,000,000)	1	($1,000,000)
Training Cost	($20,000)	1	($20,000)
Net Present Value			$183,769

B.

Present Value Indexes
Alternative 1	$1.19
Alternative 2	$1.18

C. I have two recommendation here, which is explained below in a) & b)

a) If a company having Cash Capital of $ 40 million and wan't to invest in most profitable projects, I would recommend to Invest in the Both Project,

Because, Both the project having Positive NPV as well Positive Profitability Index. Normally Positive NPV & Profitability index is greater than 1 is a good sign about Project.

b) If a company want to invest in only one alternative out of above 2, so i would recommend alternative 2 to go for investment, because NPV is more trusted source than the profitability index in the case of Multiple alternatives.