Question

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		$939,782		$621,264		$283,902
Annual net cash flows:
	Year 1	428,000		308,000		180,000
	Year 2	398,000		277,000		124,000
	Year 3	364,000		246,000		90,000

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 (maintenance equipment / ramp facilities / computer network) has the largest present value index. Although (maintenance equipment / ramp facilities / computer network) has the largest net present value, it returns less present value per dollar invested than does the (maintenance equipment / ramp facilities / computer network), as revealed by the present value indexes. The present value index for the (maintenance equipment / ramp facilities / computer network) is less than 1, indicating that it does not meet the minimum rate of return standard.

Answer 1

Solution:

Calculation of Present Value of Net Cash Flow

Maintenance Equipment

Present value of net cash flow:	Maintenance Equipment (A)	Present Value @ 12% (B)	Present Value of Net Cash Flow (A*B)
Annual Net Cash Flows:
Year 1	$428,000	0.893	$382,204
Year 2	$398,000	0.797	$317,206
Year 3	$364,000	0.712	$259,168
Present value of net cash flow total			$958,578

Ramp Facilities

Present value of net cash flow:	Ramp Facilities (A)	Present Value @ 12% (B)	Present Value of Net Cash Flow (A*B)
Annual Net Cash Flows:
Year 1	$308,000	0.893	$275,044
Year 2	$277,000	0.797	$220,769
Year 3	$246,000	0.712	$175,152
Present value of net cash flow total			$670,965

Computer Network

Present value of net cash flow:	Computer Network (A)	Present Value @ 12% (B)	Present Value of Net Cash Flow (A*B)
Annual Net Cash Flows:
Year 1	$180,000	0.893	$160,740
Year 2	$124,000	0.797	$98,828
Year 3	$90,000	0.712	$64,080
Present value of net cash flow total			$323,648

Part 1 – Net Present Value

	Maintenance Equipment	Ramp Facilities	Computer Network
Present value of net cash flow total (A)	$958,578	$670,965	$323,648
Amount to be invested (B)	$939,782	$621,264	$283,902
Net present value (A-B)	$18,796	$49,701	$39,746

Part 2 – Present Value Index

	Present value of net cash flow total (A)	Amount to be invested (B)	Present Value Index (A/B)
Maintenance Equipment	$958,578	$939,782	1.02
Ramp Facilities	$670,965	$621,264	1.08
Computer Network	$323,648	$283,902	1.14

Part 3 –

The computer network has the largest present value index. Although ramp facilities has the largest net present value, it returns less present value per dollar invested than does the computer network), 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.