Using present value techniques to evaluate alternative investment opportunities

Question

Using present value techniques to evaluate alternative investment opportunities L010-2 Speedy 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. Speedy Delivery recently acquired approximately $5.7 million of cash capital from its owners, and its president, Mason Faith, is trying to identify the most profitable way to invest these funds. Zach Singh, 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 inflows to increase by $320,000 per year. The additional vans are expected to have an average useful life of four years and a combined salvage value of $107,000. Operating the vans will require additional working capital of $39,000, which will be recovered at the end of the fourth year. In contrast, Joshua Vines, 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: The large trucks are expected to cost $800,000 and to have a four-year useful life and a $75,000 salvage value. In addition to the purchase price of the trucks, up-front training costs are expected to amount to $20,000. Speedy Delivery's management has established a 10 percent desired rate of return. (PV of $1 and PVAof $1)

Explanation / Answer

Answer:a

Answer:b PVI:

Alternative 1=1075076.91/720000=1.493

Alternative 2=1050807.32/800000=1.31

Alternative 1 Year 0 1 2 3 4 Intial investment cost -720000 Cash inflows 320000 320000 320000 320000 Salvage value 107000 Working capital -39000 39000 Total cash flows -759000 320000 320000 320000 466000 Required return 10% NPV 355076.91 Alternative 2 Year 0 1 2 3 4 Intial investment cost -800000 Upfront training cost -20000 Cash inflows 159000 324000 401000 448000 Salvage value 75000 Total cash flows -820000 159000 324000 401000 523000 Required return 10% NPV 250807.32

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