Question

Franklin 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. Franklin Delivery recently acquired approximately $6.9 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 $680,000. 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 $300,000 per year. The additional vans are expected to have an average useful life of four years and a combined salvage value of $108,000. Operating the vans will require additional working capital of $34,000, 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 $318,000 Year 3 $393,000 Year 4 $434,000 The large trucks are expected to cost $760,000 and to have a four-year useful life and a $74,000 salvage value. In addition to the purchase price of the trucks, up-front training costs are expected to amount to $10,000. Franklin 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

Purchase of Purchase of City Vans $3,33,945.00 $2,71,408.51 Trucks Ans a Net Present Value (NPV) b Present Value Index (PVI) 1.47 1.35 Net Present Value (NPV): It the difference between the present value of cash inflows and initial cash outflow. It helps in making project investment decisions. If the NPV is positive then the project should be accepted and if negative then it should ne rejected. Projects with higher NPV should be accepted in case of two mutually exclusive projects having positive net present value. NPV for Purchase of City Vans Year Particulars 0 1-4 4 ($6,80,000) ($34,000) Cost of Fleet Working Capital Cash Inflows $3,00,000 Salvage Value Release of Working Capital Net Cash Flows PV of $1 rate 10% period 4th PVA$1 rate 10% period 4 Present Value Net Present Value $1,08,000 $34,000 $1,42,000 $3,00,000 ($7,14,000) 0.68301 3.16986 ($7,14,000.00) $9,50,958.00 $96,987.00 $3,33,945.00

NPV for Purchase of Trucks Year Particulars 0 1 4 Cost of large truck Up front Training Cost operating savings Salvage Value Net Cash Flows PV of $1 rate 8% Present Value Net Present Value ($7,60,000) ($10,000) $1,50,000 $3,18,000 $3,93,000 $4,34,000 $74,000 $5,08,000 ($7,70,000) $1,50,000 $3,18,000 $3,93,000 1 0.90909 0.82645 0.75131 0.68301 ($7,70,000.00) $1,36,363.50 $2,62,811.10 $2,95,264.83 $3,46,969.08 $2,71,408.51 Profitability Index Present Value of Future Cash Flows/Initial Investment Project Present Value Investment PI (A) $10,47,945 (B) $7,14,000 (A)/(B) Purchase of City Vans 1.47 $10,41,409 $7,70,000 Purchase of Trucks 1.35