Fast Delivery is a small company that transports business packages between New Y
ID: 2362976 • Letter: F
Question
Fast 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. Fast recently acquired approximately $6 million of cash capital from its owners, and its president, Don Keenon, is trying to identify the most profitable way to invest these funds. Clarence Roy, the company's operations manager, believes that the money should be used to expand the fleet of city vans at a cost of $720,000. 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 inflow 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 $100,000. Operating the vans will require additional working capital of $40,000, which will be recovered at the end of the fourth year. In contrast, Patricia Lipa, 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 with reductions in cash flows as the following. Year 1, $160,000. Year 2, $320,000. Year 3, $400,000. Year 4, $440,000. The large trucks are expected to cost $800,000 and to have a four-year useful life and a $80,000 salvage value. In addition to the purchase price of the trucks, up-front training costs are expected to amount to $16,000. Fast Delivery's management has established a 16 percent desired rate of return. Required: a.) Determine the net present value of the two investment alternatives. b.) Calculate the present value index for each alternative. c.) Indicate which investment alternative you would recommend. Explain your choice.Explanation / Answer
a. Determine the net present value of the two investment alternatives. Alternative 1 Initial investment 720000 Salvage value 100000 life 4 depreciation 155000 Initial investment Outlay 720000 Working capital 40000 Present value of cash outflow 760000 Particular 1 2 3 4 savings 280000 280000 280000 280000 Less: depreciation:- 155000 155000 155000 155000 125000 125000 125000 125000 Add: ending cash flows working capital 40000 salvage value 100000 125000 125000 125000 265000 Add:- depreciation:- 155000 155000 155000 155000 CFAT 280000 280000 280000 420000 PVAF @ 16% 0.862069 0.743163 0.640658 0.552291 241379.3 208085.6 179384.1 231962.3 Present value of inflows 860811.3 NPV 100811.3 Alternative 2 Initial investment 800000 Salvage value 80000 life 4 depreciation 180000 Initial investment Outlay 800000 front training costs 16000 Present value of cash outflow 816000 1 2 3 4 operating saving 160000 320000 400000 440000 Add: ending cash flows working capital 80000 160000 320000 400000 520000 Pvf @ 16% 0.862069 0.743163 0.640658 0.552291 137931 237812.1 256263.1 243008.1 Present value of cash inflow 875014.3 NPV 59014.32 Note:- Since, there is no tax rate is given. So, we ignore depreciation tax shield. We only discount saving and year ending cash flows like salvage value and working capital. b. Calculate the present value index for each alternative. Present value index = present value of inflows / present value of outflows Alternative 1 Present value of cash outflow 760000 Present value of cash inflow 860811.3 Present value index 1.132646 Alternative 2 Present value of cash outflow 816000 Present value of cash inflow 875014.3 Present value index 1.072321 c. Indicate which investment alternative you would recommend. Explain your choice. On the basis of Net present value and present value index, we would recommend investment A as it would give us highest NPV as well as highest present value index as compare to investment A. So, we would recommend Patricia Lipan investment A.
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