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		$850,858		$518,264		$279,888
Annual net cash flows:
	Year 1	387,000		267,000		182,000
	Year 2	360,000		240,000		126,000
	Year 3	329,000		214,000		91,000

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 15%, 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
Total present value of net cash flow	$	$	$
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 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.

Answer 1

SOLUTION:

1) PRESENT VALUE OF NET CASH INFLOW:

YEAR	DISCOUNTING @ 15%	MAINTENANCE QUIPMENT		RAMP FACILITIES		COMPUTER NETWORK
		CASH FLOW	NPV	CASHFLOW	NPV	CASHFLOW	NPV
1	0.870	$387000	$ 336690	$267000	$232290	$182000	$158340
2	0.756	$360000	$ 272160	$240000	$181440	$126000	$95256
3	0.658	$329000	$ 216482	$214000	$140812	$91000	$59870
TOTAL		$ 1076000	$ 825332	$721000	$554542	$399000	$313466

1. NET PRESENT VALUE ANALYSIS

	MAINTENANCE EQUIPMENT	RAMP FECILITIES	COMPUTER NETWORK
PRESENT VALUE OF NET CASH FLOW TOTAL	$ 825332	$ 554542	$ 313466
LESS : AMOUNT TO BE INVESTED	$ 850858	$ 518264	$ 279888
NET PRESENT VALUE	$ (25526)	$36278	$33578

2. PRESENT VALUE INDEX

	PRESENT VALUE INDEX
MAINTENANCE	0.96
RAMP FACILITIES	1.06
COMPUTER NETWORK	1.11

MAINTENANCE=825332/850858 = 0.96

RAMP FACILITIES = 554542/518264 = 1.06

COMPUTER NETWORK = 313466/279888= 1.11

3.
THE INVESTMENT ON COMPUTER NETWORK GIVES HIGHEST PRESENT VALUE INDEX WHICH IS 1.11 THOUGH THE NET PRESENT VALUE FOR INVESTMENT ON RAMP FACILITIES IS HIGHER THAN OVER INVESTMENT PROPOSALS. BUT AS IT GIVES LESS PRESENTVALUE INDEX IT CANNOT BE CONSIDERED.THEREFORE , IT IS ADVISED TO CONTINUE WITH THE PROPOSAL ON COMPUTER NETWORK.

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