Question

Net Present Value Method, Present Value Index, and Analysis for a service company

Continental Railroad Company is evaluating three capital investment proposals by using the net present value method. Relevant data related to the proposals are summarized as follows:

		Maintenance Equipment		Ramp Facilities		Computer Network
Amount to be invested		$787,260		$520,465		$256,705
Annual net cash flows:
	Year 1	341,000		246,000		160,000
	Year 2	317,000		221,000		110,000
	Year 3	290,000		197,000		80,000

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 12%, prepare a net present value analysis for each proposal. Use the present value of $1 table above. If required, use the minus sign to indicate a negative net present value. If required, round to the nearest dollar.

	Maintenance Equipment	Ramp 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 proposal. If required, round your answers to two decimal places.

	Present Value Index
Maintenance Equipment
Ramp Facilities
Computer Network

3. The ________________ has the largest present value index. Although _________________ has the largest net present value, it returns less present value per dollar invested than does the _______________________ , as revealed by the present value indexes. The present value index for the ______________ is less than 1, indicating that it does not meet the minimum rate of return standard.

Answer 1

Project		Maintenance Equipment
Year	Cash Flow	PV factor @ 12%	Present Value
1	341,000	0.893	$          304,513
2	317,000	0.797	$          252,649
3	290,000	0.712	$          206,480
Present value of net cash flow total			$          763,642
Less: Amount to be invested			$          787,260
Net present value			$          (23,618)
Present value of net cash flow total			$          763,642
Divided by: Amount to be invested			$          787,260
Present Value Index			0.97
Project		Ramp Facilities
Year	Cash Flow	PV factor @ 12%	Present Value
1	246,000	0.893	$          219,678
2	221,000	0.797	$          176,137
3	197,000	0.712	$          140,264
Present value of net cash flow total			$          536,079
Less: Amount to be invested			$          520,465
Net present value			$             15,614
Present value of net cash flow total			$          536,079
Divided by: Amount to be invested			$          520,465
Present Value Index			1.03
Project		Computer Network
Year	Cash Flow	PV factor @ 12%	Present Value
1	160,000	0.893	$          142,880
2	110,000	0.797	$             87,670
3	80,000	0.712	$             56,960
Present value of net cash flow total			$          287,510
Less: Amount to be invested			$          256,705
Net present value			$             30,805
Present value of net cash flow total			$          287,510
Divided by: Amount to be invested			$          256,705
Present Value Index			1.12

The ________________ has the largest present value index.			Computer Network
Although _________________ has the largest net present value,			Computer Network
it returns less present value per dollar invested than does the _______________________ ,			1.12
as revealed by the present value indexes. The present value index for the ______________ is less than 1, indicating that it does not meet the minimum rate of return standard.			Maintenance Equipment
The Computer Network has the largest present value index. Although Computer Network has the largest net present value, it returns less present value per dollar invested than does the 1.12 , as revealed by the present value indexes. The present value index for the Maintenance Equipment is less than 1, indicating that it does not meet the minimum rate of return standard.