Net Present Value Method, Present Value Index, and Analysis United Bankshores, I

Question

Net Present Value Method, Present Value Index, and Analysis United Bankshores, Inc. wishes to evaluate three capital investment proposals by using the net present value method.

Relevant data related to the proposals are summarized as follows:

Branch Office Expansion Computer System Upgrade Install Internet Bill-Pay

Amount to be invested $933,690 $547,706 $335,697

Annual net cash flows:

Year 1 387,000 263,000 163,000

Year 2 360,000 237,000 112,000

Year 3 329,000 210,000 82,000

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 6%, 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.

Branch Office Expansion Computer System Upgrade Install Internet Bill-Pay

Present value of net cash flow total $ $ $

Amount to be invested $ 933,690 $ 547,706 $ 335,697

Net present value $ $ $

2. Determine a present value index for each proposal. If required, round your answers to two decimal places. Present Value Index Branch Office Expansion Computer System Upgrade Install Internet Bill-Pay

Explanation / Answer

1. Present value = cash flow*present value of $1 at 6% as the desired rate of return = 6%. Also, please note that PV factor for year 0 = 1.

(PV of 1st year cash flow of branch office expansion project = 387,000*0.943 = 364,941. Similarly, PV of other projects for years 1-3 has been calculated)

NPV for a project = sum of all the present values of its cash flows.

2. Present value index (PVI)= sum of present value of future cash flows/initial outlay

PVI of branch office expansion project = (364941+320400+276360)/933690 = 1.03

PVI of computer system upgrade = (248009+210930+176400)/547706 = 1.16

PVI of install internet = (153709+99680+68880)/335697 = 0.96

Actual cash flows Year Branch office expansion Computer system upgrade Install internet PV factor 0 -933,690 -547,706 -335,697 1.000 1 387,000 263,000 163,000 0.943 2 360,000 237,000 112,000 0.890 3 329,000 210,000 82,000 0.840 PV of cash flows Year Branch office expansion Computer system upgrade Install internet 0 -933,690.00 -547,706.00 -335,697.00 1 364,941.00 248,009.00 153,709.00 2 320,400.00 210,930.00 99,680.00 3 276,360.00 176,400.00 68,880.00 NPV 28,011.00 87,633.00 -13,428.00

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