Apnea Video Rental Store is considering the purchase of an almost new minivan to

Question

Apnea Video Rental Store is considering the purchase of an almost new minivan to deliver and pick up video tapes from customers. The minivan will cost $95,000 and is expected to last 10 years. However, the minivan's engine will need to be overhauled at a cost of $5,000 at the end of year 3. In addition, purchasing this minivan would require an immediate investment of $15,000 in working capital which would be released for investment elsewhere at the end of the 10 years. The minivan is expected to have a $10,000 salvage value at the end of 10 years. This delivery service is expected to generate net cash inflows of $20,000 per year in each of the 10 years. Apnea's cost of capital is 8%. Calculate the net present value (NPV) of this investment opportunity.

Explanation / Answer

NPV = {Net Period Cash Flow/(1+R)^T} - Initial Investment The NPV can be calculated with above formula for each year end flow or excel formula can be used. VAN COST 95000 LIFE 10 YEARS SALVAGE 10000 ENGINE OVERHAUL AT END OF YEAR 3 5000 WORKING CAPITAL REQUIRED BUT RELEASED END OF YEAR 10 15000 CASH INFLOW PER YEAR 20000 COST OF CAPITAL 8% NPV of year end in flows of 20,000,20,000,15000,20000,20000,20,000,20000,20000,20000,45000 From excel 141812.3 Initial cash out flow (95000+15000) -110000 Net Present Value of Investment 31812.3 Decision: Since the NPV of this investment is positive the Van can be purchased for business Initial Investment -110000 Year 1 net cash flow = 20000/(1+.08)^1 18518.52 Year 2 net cash flow = 20000/(1+.08)^2 17146.78 Year 3 net cash flow = 15000/(1+.08)^3 11907.48 Year 4 net cash flow = 20000/(1+.08)^4 14700.6 Year 5 net cash flow = 20000/(1+.08)^5 13611.66 Year 6 net cash flow = 20000/(1+.08)^6 12603.39 Year 7 net cash flow = 20000/(1+.08)^7 11669.81 Year 8 net cash flow = 20000/(1+.08)^8 10805.38 Year 9 net cash flow = 20000/(1+.08)^9 10004.98 Year 10 net cash flow = 45000/(1+.08)^10 20843.71 Net Present Value 31812.3

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