Question

Finch Delivery is a small company that transports business packages between New York and Chicago. It operates a fleet of small vans that moves packages to and from a central depot within each city and uses a common carrier to deliver the packages between the depots in the two cities. Finch Delivery recently acquired approximately $6.2 million of cash capital from its owners, and its president, George Hay, is trying to identify the most profitable way to invest these funds.

  

Todd Payne, the company’s operations manager, believes that the money should be used to expand the fleet of city vans at a cost of $690,000. He argues that more vans would enable the company to expand its services into new markets, thereby increasing the revenue base. More specifically, he expects cash inflows to increase by $300,000 per year. The additional vans are expected to have an average useful life of four years and a combined salvage value of $101,000. Operating the vans will require additional working capital of $49,000, which will be recovered at the end of the fourth year.

  

In contrast, Oscar Vance, the company’s chief accountant, believes that the funds should be used to purchase large trucks to deliver the packages between the depots in the two cities. The conversion process would produce continuing improvement in operating savings and reduce cash outflows as follows:

  

Year 1			Year 2			Year 3			Year 4
	$161,000			$318,000			$393,000			$434,000

  

The large trucks are expected to cost $770,000 and to have a four-year useful life and a $74,000 salvage value. In addition to the purchase price of the trucks, up-front training costs are expected to amount to $18,000. Finch Delivery’s management has established a 8 percent desired rate of return. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)

  

Required

1. a.&b. Determine the net present value and present value index for each investment alternative. (Enter answers in whole dollar, not in million. Negative amounts should be indicated by a minus sign. Round your intermediate calculations and final answers to 2 decimal places.)

Answer 1

a)

Computation Of NPV
Investment in VAN
Alternative 1
Particular	Period	PV factor	Amount	Present value
Cash Outflows :		,@ 8 %
Cost of van	0	1	690000	690000
Working capital	0	1	49000	49000
Present value of cash outflow (A)				739000
Cash inflows
Annual increase in cash inflows
Year 1	1	0.92593	300000	277779
year 2	2	0.85734	300000	257202
Year 3	3	0.79383	300000	238149
Year 4	4	0.73503	300000	220509
Salvage Value	4	0.73503	101000	74238.03
Recovery of working capital	4	0.73503	49000	36016.47
Present value of cash inflow (B)]				1103893.5
Net Present value ( B - A)				364893.5

Computation Of NPV
Investment in truck
Alternative 2
Particular	Period	PV factor	Amount	Present value
Cash Outflows :		,@ 8 %
Cost of truck	0	1	770000	770000
Upfront training cost	0	1	18000	18000
Present value of cash outflow (A)				788000
Cash inflows
Annual increase in cash inflows
Year 1	1	0.92593	161000	149074.73
year 2	2	0.85734	318000	272634.12
Year 3	3	0.79383	393000	311975.19
Year 4	4	0.73503	434000	319003.02
Salvage Value	4	0.73503	74000	54392.22
Present value of cash inflow (B)]				1107079.3
Net Present value ( B - A)				319079.3

b )

Computation of present value index
Particular	Alternative 1	Alternative 2
	Van	Truck
Present value of cash inflow	1103893.5	1107079.3
Initial cash outflow	739000	788000
Present value Index	1.49	1.4
( PV OF CASH INFLOW / PV OF CASH OUTFLOW )