Question

Perez 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. Perez Delivery recently acquired approximately $6.0 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 $720,000. 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 $340,000 per year. The additional vans are expected to have an average useful life of four years and a combined salvage value of $94,000. Operating the vans will require additional working capital of $31,000, 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 $150,000 Year 2 Year 3 $312,000 $394,000 Year 4 $438,000 The large trucks are expected to cost $800,000 and to have a four-year useful life and a $88,000 salvage value. In addition to the purchase price of the trucks, up-front training costs are expected to amount to $11,000. Perez 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. (Round your intermediate calculations and final answers to 2 decimal places. Enter your answer in whole dollars and not in millions.) Purchase of Purchase of City Vans Trucks Net Present Value a.(NPV) Present Value Index (PVI)

Answer 1

a) Net Present Value Purchase of City Vans Year Cost of vans Incremental revenue Salvage value Working capital Recovery of working capital Net cash Flow Present value factor @10% of cash Flows $7,20,000.00 $0.00 $0.00 $31,000.00 $0.00 $7,51,000.00 1 $0.00 $3,40,000.00 $0.00 $0.00 $0.00 $3,40,000.00 0.909 2 3 4 $0.00 $0.00 $0.00 $3,40,000.00 $3,40,000.00 $3,40,000.00 $0.00 $0.00 $94,000.00 $0.00 $0.00 $0.00 $0.00 $0.00 $31,000.00 $3,40,000.00 $3,40,000.00 $4,65,000.00 0.826 0.751 0.683 $7,51,000.00 $3,09,060.00 $2,80,840.00 $2,55,340.00 $3,17,595.00 Net Present value (i.e. Sum of present value of cash Flows) $4,11,835.00 2 $0.00 3 $0.00 4 $0.00 $0.00 Purchase of Trucks Year Cost of Trucks Training Revenue Salvage value Net cash flow Present value factor @10% Present value of cash Flows $8,00,000.00 $1,000.00 $0.00 $0.00 $8,01,000.00 $1,50,000.00 $0.00 $1,50,000.00 0.909 $3,12,000.00 $3,94,000.00 $4,38,000.00 $0.00 $0.00 $88,000.00 $3,12,000.00 $3,94,000.00 $5,26,000.00 .826 0.751 0.683 1 0 -$8,01,000.00 $1,36,350.00 $2,57,712.00 $2,95,894.00 $3,59,258.00 Net Present value (i.e. Sum of present value of cash Flows) $2,48,214.00

b) Present value index Formula = Net Present value / Initial Investment Purchase of City Vans Net Present value $4,11,835.00 Initial Invesаtment $7,51,000.00 Present value index 0.55 Purchase of Trucks Net Present value $2,48,214.00 Initial Invesаtment $8,01,000.00 Present value index 0.31 Purchase of Trucks Purchase of City Vans $4,11,835.00 a) Net Present Value $2,48,214.00 0.31 b) Present value index 0.55