Net Present Value Method for a Service Company
Coast-to-Coast Inc. is considering the purchase of an additional delivery vehicle for $39,000 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 $67,000 per year for each of the next five years. A driver will cost $46,000 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 $2,000 per year.
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 |
a. Determine the expected annual net cash flows from the delivery truck investment for 20Y1-20Y5.
Annual Net Cash Flow | |
20Y1 | $ |
20Y2 | $ |
20Y3 | $ |
20Y4 | $ |
20Y5 | $ |
b. Compute the net present value of the investment, assuming that the minimum desired rate of return is 20%. 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 annual net cash flows | $ |
Investment | |
Net present value | $ |
c. Is the additional truck a good investment
based on your analysis?
, because the net present value is .
Req a. | |||||||
Annual Net cash flows | |||||||
Year-1 | YEar2 | Year-3 | Year-4 | Year-5 | |||
Annual Incremental revenue | 67000 | 67000 | 67000 | 67000 | 67000 | ||
Annual Driver salary | -46000 | -50000 | -54000 | -58000 | -62000 | ||
Annual Operating cost | -2000 | -2000 | -2000 | -2000 | -2000 | ||
Residual value | 7000 | ||||||
Net cash Flows | 19000 | 15000 | 11000 | 7000 | 10000 | ||
Year | Annual cash net flows | ||||||
2001 | 19000 | ||||||
2002 | 15000 | ||||||
2003 | 11000 | ||||||
2004 | 7000 | ||||||
2005 | 10000 | ||||||
Req b. | |||||||
Year | Annual cash net flows | PVF at 20% | Present value | ||||
2001 | 19000 | 0.833 | 15827 | ||||
2002 | 15000 | 0.694 | 10410 | ||||
2003 | 11000 | 0.579 | 6369 | ||||
2004 | 7000 | 0.482 | 3374 | ||||
2005 | 10000 | 0.402 | 4020 | ||||
Present value of inflows | 40,000 | ||||||
Less: Investment | 39000 | ||||||
Net present value | 1000 | ||||||
Yes, it is a good investment as NPV is positive |
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