Question

Franklin 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. Franklin Delivery recently acquired approximately $6.7 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 $280,000 per year. The additional vans are expected to have an average useful life of four years and a combined salvage value of $96,000. Operating the vans will require additional working capital of $32,000, 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 $167,000 $315,000 $404,000 $437,000 The large trucks are expected to cost $770,000 and to have a four-year useful life and a $86,000 salvage value. In addition to the purchase price of the trucks, up-front training costs are expected to amount to $17,000. Franklin Delivery’s management has established a 14 percent desired rate of return. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.) Required a.&b. Determine the net present value and present value index for each investment alternative. (Negative amounts should be indicated by a minus sign. Round your intermediate calculations and final answers to 2 decimal places.)

Answer 1

cost of vans		690000		cost of delivery truck		770000
investment in working capital		32000		upfront training		17000
cash outflow		722000		cash outflow		787000
Year	operating profit = revenue-operating cost	present value of cash flow = cash flow/(1+r)^n r=14%		Year	operating profit = revenue-operating cost	present value of cash flow = cash flow/(1+r)^n r=14%
1	280000	245614		1	167000	146491.2
2	280000	215450.9		2	315000	242382.3
3	280000	188992		3	404000	272688.5
4	280000	165782.5		4	437000	258739.1
4	128000	75786.28		4	86000	50918.9
sum of present value of cash flow		891625.7		sum of present value of cash flow		971220
cash outflow		722000		cash outflow		787000
net present value		169625.7		net present value		184220
Profitability index	sum of present value of cash inflow/cash outflow	1.234939		Profitability index	sum of present value of cash inflow/cash outflow	1.234079
Company should choose delivery truck as its NPV is better than NPVof Vans