Question

Net Present Value Method, Present Value Index, and Analysis

Donahue Industries Inc. wishes to evaluate three capital investment projects by using the net present value method. Relevant data related to the projects are summarized as follows:

		Product Line Expansion		Distribution Facilities		Computer Network
Amount to be invested		$4,000,000		$2,500,000		$500,000
Annual net cash flows:
	Year 1	4,200,000		1,000,000		600,000
	Year 2	3,600,000		1,200,000		600,000
	Year 3	3,000,000		1,300,000		550,000

Present Value of $1 at Compound Interest
Year	6%	10%	12%	15%	20%
1	0.943	0.909	0.893	0.870	0.833
2	0.890	0.826	0.797	0.756	0.694
3	0.840	0.751	0.712	0.658	0.579
4	0.792	0.683	0.636	0.572	0.482
5	0.747	0.621	0.567	0.497	0.402
6	0.705	0.564	0.507	0.432	0.335
7	0.665	0.513	0.452	0.376	0.279
8	0.627	0.467	0.404	0.327	0.233
9	0.592	0.424	0.361	0.284	0.194
10	0.558	0.386	0.322	0.247	0.162

Required:

1. Assuming that the desired rate of return is 20%, prepare a net present value analysis for each project. Use the present value of $1 table presented above in your computations. If the net present value is negative, enter a negative amount.

	Product Line Expansion		Distribution Facilities		Computer Network
Present value of net cash flow total	$		$		$
Amount to be invested
Net present value	$		$		$

2. Determine a present value index for each project. Round your answers to two decimal places.

	Present Value Index (Rounded)
Product Line Expansion
Distribution Facilities
Computer Network

Answer 1

Calculation of present value of cash flow
Product line expansion
years	Cash flow	PVF @20%	Present value of cash flow
1	4200000	0.833	3498600
2	3600000	0.694	2498400
3	3000000	0.579	1737000
	total present value		7734000
Distribution facilities
years	Cash flow	PVF @20%	Present value of cash flow
1	1000000	0.833	833000
2	1200000	0.694	832800
3	1300000	0.579	752700
	total present value		2418500
Computer network
years	Cash flow	PVF @20%	Present value of cash flow
1	600000	0.833	499800
2	600000	0.694	416400
3	550000	0.579	318450
	total present value		1234650
Net present value analysis
		Product line expansion	Distribution facilities	Computer network
present value of net cash flow total		7734000	2418500	1234650
amount to be invested		-4000000	-2500000	-500000
Net present value		3734000	-81500	734650
2) present value index = present value of cash flow/amount to be invested
		present value index (rounded)
Production line expansion		7734000/4000000 = 2.47
Distribution facilities		2418500/2500000 = 0.97
Computer network		1234650/500000   = 2.47

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