Question

Net Present Value Method, Present Value Index, and Analysis

United Bankshores, Inc. wishes to evaluate three capital investment proposals by using the net present value method. Relevant data related to the proposals are summarized as follows:

		Branch Office Expansion		Computer System Upgrade		Install Internet Bill-Pay
Amount to be invested		$837,326		$465,641		$258,271
Annual net cash flows:
	Year 1	320,000		218,000		141,000
	Year 2	298,000		196,000		97,000
	Year 3	272,000		174,000		71,000

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 6%, 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.

	Branch Office Expansion	Computer System Upgrade	Install Internet Bill-Pay
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
Branch Office Expansion
Computer System Upgrade
Install Internet Bill-Pay

Answer 1

Answer:

1. Present value = cash flow*present value of $1 at 6% as the desired rate of return = 6%. Also, please note that PV factor for year 0 = 1. (PV of 1st year cash flow of branch office expansion project = 320000*0.943 = 301760. Similarly, PV of other projects for years 1-3 has been calculated) NPV for a project = sum of all the present values of its cash flows. Actual cash flows Year Branch office expansion Computer system upgrade Install internet PV factor 0 -837326 -465641 -258271 1.000 1 320000 218000 141000 0.943 2 298000 196000 97000 0.890 3 272000 174000 71000 0.840 PV of cash flows Year Branch office expansion Computer system upgrade Install internet 0 -837326 -465641 -258271 1 301760 205574 132963 2 265220 174440 86330 3 228480 146160 59640 NPV -41,866 60,533 20,662 2. Present value index (PVI)= sum of present value of future cash flows/initial outlay PVI of branch office expansion project = (301760+265220+228480)/837326 = 0.95 PVI of computer system upgrade = (205574+174440+146160)/465641 = 1.13 PVI of install internet = (132963+86330+59640)/258270 = 1.08