Problem 10-16A Using present value techniques to evaluate alternative investment

Question

Problem 10-16A Using present value techniques to evaluate alternative investment opportunities LO 10 2 Swift 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. Swift Delivery recently acquired approximately $4 million of cash capital from its owners, and its president, George Hay, is trying to identify the most profitable way to invest these funds Todd Payne, the company's operations manager, believes that the money should be used to expand the fleet of city vans at a cost of $900,000. 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 $325,000 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 $50,000, which will be recovered at the end of the fourth year. In contrast, Oscar Vance, 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: Year 4 $175,000 375,000 450,000 $500,000 Year 1 Year 2 The large trucks are expected to cost $1,000,000 and to have a four-year useful life and a $81,250 salvage value. In addition to the purchase price of the trucks, up-front training costs are expected to amount to $20,000. Swift Delivery's management has established a 10 percent desired rate of return. (PV of $1 and PVA of $1 (Use appropriate factor(s) from the tables provided.) Required a.&b.; Determine the net present value and present value index for each investment alternative. (Round your intermediate calculations and final answers to 2 decimal places.) urchase of City Purchase o Vans Trucks a. Net Present Value (NPV) b. Present Value Index (PVI)

Explanation / Answer

Purchase of city van Purchase of trucks Nature of cash flow Year Cash flow PVIF@10% Present value Cash flow PVIF@10% Present value Initial cost 0 -900000 1 -900000 -1000000 1 -1000000 Working capital 0 -50000 1 -50000 0 1 0 Upfront training cost 0 0 1 0 -20000 1 -20000 Cash Inflow 1 325000 0.9090909 295454.5 175000 0.9090909 159090.9 Cash Inflow 2 325000 0.8264463 268595 375000 0.8264463 309917.4 Cash Inflow 3 325000 0.7513148 244177.3 450000 0.7513148 338091.7 Cash Inflow 4 325000 0.6830135 221979.4 500000 0.6830135 341506.7 Salvage Value 4 100000 0.6830135 68301.35 81250 0.6830135 55494.84 Recovery of working capital 4 50000 0.6830135 34150.67 0 0.6830135 0 Net Present Value 182658.3 184101.5 Total Inflow 1132658 1204101 Total outflow 950000 1020000 Present Value Index =Total Inflows/Total outflows 1.192272 1.180492 Purchase of city van Purchase of trucks Net Present Value 182658.29 184101.5 Present Value Index 1.1922719 1.180492

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