Net Present Value Method for a Service Company AM Express Inc. is considering th

Question

Net Present Value Method for a Service Company

AM Express Inc. is considering the purchase of an additional delivery vehicle for $49,000 on January 1, 20Y1. The truck is expected to have a five-year life with an expected residual value of $7,000 at the end of five years. The expected additional revenues from the added delivery capacity are anticipated to be $78,000 per year for each of the next five years. A driver will cost $55,000 in 20Y1, with an expected annual salary increase of $4,000 for each year thereafter. The annual operating costs for the truck are estimated to be $3,000 per year.

a. Determine the expected annual net cash flows from the delivery truck investment for 20Y1-20Y5.

b. Calculate the net present value of the investment, assuming that the minimum desired rate of return is 12%. Use the table of the present value of $1 presented above. When required, round to the nearest dollar. If required, use the minus sign to indicate a negative net present value.

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

Explanation / Answer

a. Calculation of annual net cash flow = Annual cash inflow - Annual cash outflow

b. Calculation of Net present value (NPV)

Years Cash inflow Cash outflow    Annual Net cash flow Residual value Expected additional revenue Expected salary of driver Operating costs 20Y1       78,000     55,000         3,000 20,000 20Y2       78,000     59,000         3,000 16,000 20Y3       78,000     63,000         3,000 12,000 20Y4       78,000     67,000         3,000     8,000 20Y5     7,000       78,000     71,000         3,000 11,000

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