Fast 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. Fast Delivery recently acquired approximately $6million of cash capital from it owners, and its president Don, is trying to identify the most profitable way to invest these funds.
One 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 inflow to increase by $280.00 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 $40,000 which will be recovered at the end of the fourth year.
In contrast, the company chief accountant, believes that the funds should be used to purchased large trucks to deliver the package between the depots in the two cities. The conversion process would produce continuing improvement in operating savings with reductions in cash outflow as the following.
Year 1 $160,000
Year 2 $320,000
Year 3 $400,000
Year 4 $440,000
The large trucks are expected to cost $800,000 and to have a four-year useful life and a $80,000 salvage value. In additional to the purchase price of the trucks, up-front training cost are expected to amount to $16,000. Fast Delivery's management has established a 16 percent desired rate of return.
Required
A. Determine the net present value of the two investment alternatives.
B. Calculate the present value index for each alternative.
C. Indicate which investment alternative you would recommend. Explain the choice.