Question

Problem 16-1 Oriole Delivery is a small company that transports business packages between Denver and Miami. It operates a fleet of small vans that moves packages to and from a central distribution center within each city and uses a service to deliver the packages between the distribution centers in the two cities. Oriole recently acquired approximately $6 mil lion of cash capital from its owners, and its President, is trying to identify the most profitable way to invest these funds. The company's Chief Operating Officer, believes that the money should be used to expand the fleet of city vans at a cost of company to expand its services into new markets, thereby increasing the revenue base. More specifically, he expects cash inflows to increase by expected to have an average useful life of four years and a combined salvage value of $1,440,000 He argues that more vans would enable the $560,000 per year. The additional vans are $C Operating the vans will require additional working capital of which will be recovered at the end of the fourth year. $80,000 In contrast, the company's Chief Accountant, believes that the funds should be used to purchase large trucks to deliver the packages between the distribution centers in the two cities. The conversion process would produce continuing improvement in operating savings with reductions in cash outflows as the following. Year 1 $352,000 Year 3 $880,000 Year 2 $704,000 Year 4 $968,000 $1,600,000 salvage value. In addition to the purchase price 4 The large trucks are expected to cost year useful life and a of the trucks, up-front training costs are expected to be and have a S0 $200,000 Oriole Delivery's management has established a 11% desired rate of return. REQUIRED lgnore Depreciation and Tax as they are imbedded in the cash inflow and cash outflow data 1. Determine the net present value of the two investment alternatives 2. Calculate the present value index for each alternative. 3. Indicate which investment alternative you would recommend. Explain your choice. Set up a mini table of present value factors to make your calculations easier.

Answer 1

Investment Option 1
Cost of Vans = $1440000
Working Capital Required = $80000
Total Investment = $1520000

NPV = Presnt value of cash flows - Investment
Present Value Index = PV of cash flows / Investment

Year	Annual Increase in Cash flow	Recovery of Working Capital	Total Cash Inflow	PV Factor @11%	PV of cash inflows
1	$   560,000.00		$ 560,000.00	0.9009	$     504,505
2	$   560,000.00		$ 560,000.00	0.8116	$     454,509
3	$   560,000.00		$ 560,000.00	0.7312	$     409,467
4	$   560,000.00	$     80,000.00	$ 640,000.00	0.6587	$     421,588
	Total				$ 1,790,068
	Investment				$ 1,520,000
	NPV				$     270,068
	PI				1.18

Investment Option 2
Cost of Vans = $1600000
Training Cost = $200000
Total Investment = $1800000

NPV = Presnt value of cash flows - Investment
Present Value Index = PV of cash flows / Investment

Year	Annual Increase in Cash flow	PV Factor @11%	PV of cash inflows
1	$   352,000.00	0.9009	$        317,117
2	$   704,000.00	0.8116	$        571,382
3	$   880,000.00	0.7312	$        643,448
4	$   968,000.00	0.6587	$        637,652
	Total		$    2,169,599
	Investment		$    1,800,000
	NPV		$        369,599
	PI		1.21

I would recommend Investment option 2 of large trucks, this is because this option has higher PI than Investment option 1.