Question

pr.25

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		$841,093		$559,622		$284,425
Annual net cash flows:
	Year 1	414,000		306,000		195,000
	Year 2	385,000		275,000		135,000
	Year 3	352,000		245,000		98,000

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 20%, 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

Answer 1

Answer 1.

Maintenance Equipment:

Amount to be invested = $841,093

Present Value of Net Cash Flows = $414,000 * PV of $1 (20%, 1) + $385,000 * PV of $1 (20%, 2) + $352,000 * PV of $1 (20%, 3)
Present Value of Net Cash Flows = $414,000 * 0.833 + $385,000 * 0.694 + $352,000 * 0.579
Present Value of Net Cash Flows = $815,860

Net Present Value = Present Value of Net Cash Flows - Amount to be invested
Net Present Value = $815,860 - $841,093
Net Present Value = -$25,233

Ramp Facilities:

Amount to be invested = $559,622

Present Value of Net Cash Flows = $306,000 * PV of $1 (20%, 1) + $275,000 * PV of $1 (20%, 2) + $245,000 * PV of $1 (20%, 3)
Present Value of Net Cash Flows = $306,000 * 0.833 + $275,000 * 0.694 + $245,000 * 0.579
Present Value of Net Cash Flows = $587,603

Net Present Value = Present Value of Net Cash Flows - Amount to be invested
Net Present Value = $587,603 - $559,622
Net Present Value = $27,981

Computer Network:

Amount to be invested = $284,425

Present Value of Net Cash Flows = $195,000 * PV of $1 (20%, 1) + $135,000 * PV of $1 (20%, 2) + $98,000 * PV of $1 (20%, 3)
Present Value of Net Cash Flows = $195,000 * 0.833 + $135,000 * 0.694 + $98,000 * 0.579
Present Value of Net Cash Flows = $312,867

Net Present Value = Present Value of Net Cash Flows - Amount to be invested
Net Present Value = $312,867 - $284,425
Net Present Value = $28,442

Answer 2.

Maintenance Equipment:

Amount to be invested = $841,093

Present Value of Net Cash Flows = $414,000 * PV of $1 (20%, 1) + $385,000 * PV of $1 (20%, 2) + $352,000 * PV of $1 (20%, 3)
Present Value of Net Cash Flows = $414,000 * 0.833 + $385,000 * 0.694 + $352,000 * 0.579
Present Value of Net Cash Flows = $815,860

Profitability Index = Present Value of Net Cash Flows / Amount to be invested
Profitability Index = $815,860 / $841,093
Profitability Index = 0.97

Ramp Facilities:

Amount to be invested = $559,622

Present Value of Net Cash Flows = $306,000 * PV of $1 (20%, 1) + $275,000 * PV of $1 (20%, 2) + $245,000 * PV of $1 (20%, 3)
Present Value of Net Cash Flows = $306,000 * 0.833 + $275,000 * 0.694 + $245,000 * 0.579
Present Value of Net Cash Flows = $587,603

Profitability Index = Present Value of Net Cash Flows / Amount to be invested
Profitability Index = $587,603 / $559,622
Profitability Index = 1.05

Computer Network:

Amount to be invested = $284,425

Present Value of Net Cash Flows = $195,000 * PV of $1 (20%, 1) + $135,000 * PV of $1 (20%, 2) + $98,000 * PV of $1 (20%, 3)
Present Value of Net Cash Flows = $195,000 * 0.833 + $135,000 * 0.694 + $98,000 * 0.579
Present Value of Net Cash Flows = $312,867

Profitability Index = Present Value of Net Cash Flows / Amount to be invested
Profitability Index = $312,867 / $284,425
Profitability Index = 1.10