Question

Net Present Value Method for a Service Company

AM Express Inc. is considering the purchase of an additional delivery vehicle for $27,000 on January 1, 20Y1. The truck is expected to have a five-year life with an expected residual value of $5,000 at the end of five years. The expected additional revenues from the added delivery capacity are anticipated to be $52,000 per year for each of the next five years. A driver will cost $37,000 in 20Y1, with an expected annual salary increase of $3,000 for each year thereafter. The annual operating costs for the truck are estimated to be $2,000 per year.

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

a. Determine the expected annual net cash flows from the delivery truck investment for 20Y1-20Y5.

	Annual Net Cash Flow
20Y1	$
20Y2	$
20Y3	$
20Y4	$
20Y5	$

b. Calculate the net present value of the investment, assuming that the minimum desired rate of return is 20%. Use the table of the present value of $1 presented above. When required, round to the nearest dollar. If required, use the minus sign to indicate a negative net present value.

Present value of annual net cash flows	$
Investment	$
Net present value	$

c. Is the additional truck a good investment based on your analysis?
, because the net present value is .

Answer 1

Ans- a-The expected annual net cash flows for 20Y1-20Y5:-

	20Y1	20Y2	20Y3	20Y4	20Y5
Revenue	$52,000	$52,000	$52,000	$52,000	$52,000
Less: Driver Cost	-$37,000	-$40,000	-$43,000	-$46,000	-$49,000
Less: Operating Cost	-$2,000	-$2,000	-$2,000	-$2,000	-$2,000
Net Income	$13,000	$10,000	$7,000	$4,000	$1,000
Salvage Value	-	-	-	-	$5,000
Net Cash Flow	$13,000	$10,000	$7,000	$4,000	$6,000

Ans-b- The net present value of investment:-

Year	Cash Flow (a)	Discount factor at 20% (b)	PV (a*b)
20Y1	$13,000	0.833	$10,829
20Y2	$10,000	0.694	$6,940
20Y3	$7,000	0.579	$4,053
20Y4	$4,000	0.482	$1,928
20Y5	$6,000	0.402	$2,412
		PV of annual net cash flow	$26,162
		Investment	$27,000
		Net Present Value	$-838

Ans-c-According to Net Present Value additional truck investment is not a good investment because Net Present Value is Negative (-$838).

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