Question

Stuart 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. Stuart Delivery recently acquired approximately $5.7 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 $660,000. 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 $310,000 per year. The additional vans are expected to have an average useful life of four years and a combined salvage value of $101,000. Operating the vans will require additional working capital of $33,000, 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 1			Year 2			Year 3			Year 4
	$159,000			$314,000			$401,000			$438,000

The large trucks are expected to cost $740,000 and to have a four-year useful life and a $76,000 salvage value. In addition to the purchase price of the trucks, up-front training costs are expected to amount to $18,000. Stuart 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

1. 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. Enter your answer in whole dollars and not in millions.)

Answer 1

Requirement A

Calculation of Net present value
Present value of cash inflow
Year	Particulars	Amount($)	Present value factor @ 10%	Present value($)
1	Cash inflows	310,000	0.90	279,000
2	Cash inflows	310,000	0.82	254,200
3	Cash inflows	310,000	0.75	232,500
4	Cash inflows	310,000	0.68	210,800
4	Working capital	33,000	0.68	22,440
4	Salvage	101,000	0.68	68,680
4	Salvage for large trucks	76,000	0.68	51,680
		Total	A	1,119,300
Present value of cash outflow
Year	Particulars	Amount($)	Present value factor @ 10%	Present value($)
0	Expansion	660,000	1	660,000
0	Working capital	33,000	1	33,000
0	Purchase of large trucks	740,000	1	740,000
0	Training cost	18,000	1	18,000
1	Reduction of cash outflow	(159,000)	0.90	(143,100)
2	Reduction of cash outflow	(314,000)	0.82	(257,480)
3	Reduction of cash outflow	(401,000)	0.75	(300,750)
4	Reduction of cash outflow	(438,000)	0.68	(297,840)
		Total	B	451,830
		Net present value	A-B	667,470

Requirement B

Present value index

=(NPV+Initial investment)/ Initial investment

=(667470+1451000)/1451000

=1.46

Working note:

Initial investment
Sr. No.	Particulars	Amount($)
1	Expansion	660,000
2	Working capital	33,000
3	Purchase of large trucks	740,000
4	Training cost	18,000
	Total	1,451,000