Question

Net Present Value Method for a Service Company

AM Express Inc. is considering the purchase of an additional delivery vehicle for $31,000 on January 1, 20Y1. The truck is expected to have a five-year life with an expected residual value of $7,000 at the end of five years. The expected additional revenues from the added delivery capacity are anticipated to be $52,000 per year for each of the next five years. A driver will cost $38,000 in 20Y1, with an expected annual salary increase of $3,000 for each year thereafter. The annual operating costs for the truck are estimated to be $2,000 per year.

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

a. Determine the expected annual net cash flows from the delivery truck investment for 20Y1-20Y5.

	Annual Net Cash Flow
20Y1	$
20Y2	$
20Y3	$
20Y4	$
20Y5	$

b. Calculate the net present value of the investment, assuming that the minimum desired rate of return is 6%. Use the table of the present value of $1 presented above. When required, round to the nearest dollar. If required, use the minus sign to indicate a negative net present value.

Present value of annual net cash flows	$
Investment	$
Net present value	$

c. Is the additional truck a good investment based on your analysis?
, because the net present value is  .

Answer 1

Solution a:

Computation of annual net cash flows - AM Express
Particulars	20Y1	20Y2	20Y3	20Y4	20Y5
Additional revenues	$52,000.00	$52,000.00	$52,000.00	$52,000.00	$52,000.00
Driver salary	-$38,000.00	-$41,000.00	-$44,000.00	-$47,000.00	-$50,000.00
Operating costs	-$2,000.00	-$2,000.00	-$2,000.00	-$2,000.00	-$2,000.00
Residual value					$7,000.00
Annual net cash flow	$12,000.00	$9,000.00	$6,000.00	$3,000.00	$7,000.00

Solution b:

Computation of NPV
Particulars	Amount	Period	PV Factor	Present Value
Cash Outflows:
Cost of Truck	$31,000.00	0	1	$31,000
Present Value of Cash Outflows (A)				$31,000
Cash Inflows:
20Y1	$12,000.00	1	0.943	$11,316
20Y2	$9,000.00	2	0.890	$8,010
20Y3	$6,000.00	3	0.840	$5,040
20Y4	$3,000.00	4	0.792	$2,376
20Y5	$7,000.00	5	0.747	$5,229
Present Value of Cash Inflows (B)				$31,971
Net Present Value (B-A)				$971

Solution c:

As NPV is positive therefore additional truck is a good investment