Lilly Painting Company is considering whether to purchase a new spray paint mach

Question

Lilly Painting Company is considering whether to purchase a new spray paint machine that costs $4,000. The machine is expected to save labor, increasing net income by $600 per year. The effective life of the machine is 15 years according to the manufacturer's estimate. Required Determine the unadjusted rate of return based on the average cost of the investment. What is the predominant shortcoming of using the unadjusted rate of return to evaluate in-vestment opportunities? Computing the payback period and unadjusted rate of return for one investment opportunity Foy Rentals can purchase a van that costs $60,000; it has an expected useful life of three years and no salvage value. Foy uses straight-line depreciation. Expected revenue is $30,000 per year. Determine the payback period. Determine the unadjusted rate of return based on the average cost of the investment. Using present value techniques to evaluate alternative investment opportunities Fast Delivery is a small company that ports bUsingss 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 recently acquired approximately $6 million of cash capital from its owners, and its president, Don Keenon, is trying to identify the most profitable way to invest these funds. Clarence Roy, the company's operations 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 inflows to increase by $280,000 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 $40,000, which will be recovered at the end of the fourth year. In contrast, Patricia Lipa, 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 with reductions in cash outflows as the following. The large trucks are expected to cost $800,000 and to have a four-year useful life and a $80,0 salvage value. In addition to the purchase price of the trucks, up-front training costs are expected to amount to $16,000. Fast Delivery's management has established a 16 percent desired rate of return. Required Determine the net present value of the two investment alternatives. Calculate the present value index for each alternative. Indicate which investment alternative you would recommend. Explain your choice. The large trucks are expected to cost S800,000 and to have a four-year useful life and a S80,0 salvage value. In addition to the purchase price of the trucks, up-front training costs are expected to amount to SI6,000. Fast Delivery's management has established a 16 percent desired rate of return. Required Determine the net present value of the two investment alternatives. Calculate the present value index for each alternative. Indicate which investment alternative you would recommend. Explain your choice.

Explanation / Answer

c. On the basis of Net present value and present value index, we would recommend investment A as it would give us highest NPV as well as highest present value index as compare to investment A. So, we would recommend Patricia Lipan investment A.

a. Determine the net present value of the two investment alternatives. Alternative 1 Initial investment 720000 Salvage value 100000 life 4 depreciation 155000 Initial investment Outlay 720000 Working capital 40000 Present value of cash outflow 760000 Particular 1 2 3 4 savings 280000 280000 280000 280000 Less: depreciation:- 155000 155000 155000 155000 125000 125000 125000 125000 Add: ending cash flows working capital 40000 salvage value 100000 125000 125000 125000 265000 Add:- depreciation:- 155000 155000 155000 155000 CFAT 280000 280000 280000 420000 PVAF @ 16% 0.862069 0.743163 0.640658 0.552291 241379.3 208085.6 179384.1 231962.3 Present value of inflows 860811.3 NPV 100811.3 Alternative 2 Initial investment 800000 Salvage value 80000 life 4 depreciation 180000 Initial investment Outlay 800000 front training costs 16000 Present value of cash outflow 816000 1 2 3 4 operating saving 160000 320000 400000 440000 Add: ending cash flows working capital 80000 160000 320000 400000 520000 Pvf @ 16% 0.862069 0.743163 0.640658 0.552291 137931 237812.1 256263.1 243008.1 Present value of cash inflow 875014.3 NPV 59014.32 Note:- Since, there is no tax rate is given. So, we ignore depreciation tax shield. We only discount saving and year ending cash flows like salvage value and working capital.

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