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		$706,350		$461,534		$233,498
Annual net cash flows:
	Year 1	318,000		229,000		149,000
	Year 2	296,000		206,000		103,000
	Year 3	270,000		183,000		75,000

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
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 has the largest present value index. Although has the largest net present value, it returns less present value per dollar invested than does the , as revealed by the present value indexes. The present value index for the is less than 1, indicating that it does not meet the minimum rate of return standard

Answer 1

1.

Maintenance Equipment
Year	Cash flow	PV of $1 @ 15 %	PV
0	$                    (706,350)	1	$        (706,350.00)
1	$                      318,000	0.87	$          276,660.00
2	$                      296,000	0.756	$          223,776.00
3	$                      270,000	0.658	$          177,660.00
			$          (28,254.00)

Ramp Facilities
Year	Cash flow	PV of $1 @ 15 %	PV
0	$                    (461,534)	1	$        (461,534.00)
1	$                      229,000	0.87	$          199,230.00
2	$                      206,000	0.756	$          155,736.00
3	$                      183,000	0.658	$          120,414.00
			$            13,846.00

Computer Network
Year	Cash flow	PV of $1 @ 15 %	PV
0	$                    (233,498)	1	$        (233,498.00)
1	$                      149,000	0.87	$          129,630.00
2	$                      103,000	0.756	$            77,868.00
3	$                         75,000	0.658	$            49,350.00
			$            23,350.00

	Maintenance Equipment	Ramp Facilities	Computer Network
Present value of net cash flow total	$   678,096	$ 475,380	$ 256,848
Amount to be invested	$   706,350	$ 461,534	$ 233,498
Net Present value	-$    28,254	$    13,846	$    23,350

2.

	Maintenance Equipment	Ramp Facilities	Computer Network
Present value of net cash flow total	$         678,096.00	$ 475,380.00	$ 256,848.00
Amount to be invested	$          706,350.00	$   461,534	$   233,498
Present Value Index	$                       0.96	$    1.03	$     1.10

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 Maintenance Equipment is less than 1, indicating that it does not meet the minimum rate of return standard.