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

Question

9.

Net Present Value Method for a Service Company

AM Express Inc. is considering the purchase of an additional delivery vehicle for $46,000 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 $71,000 per year for each of the next five years. A driver will cost $50,000 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 10%. 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.

c. Is the additional truck a good investment based on your analysis?
, because the net present value is .

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

1) Particulars 2001 2002 2003 2004 2005 Additional revenue $   71,000.00 $   71,000.00 $   71,000.00 $        71,000.00 $   71,000.00 Less: Diver Salary $ (50,000.00) $ (54,000.00) $ (58,000.00) $     (62,000.00) $ (66,000.00) Operation Cost $   (3,000.00) $   (3,000.00) $   (3,000.00) $        (3,000.00) $   (3,000.00) Add: Residual value $                   -   $                   -   $                   -   $                       -   $      7,000.00 Net Cash Flow $   18,000.00 $   14,000.00 $   10,000.00 $          6,000.00 $      9,000.00 2) Calculation of NPV: Year PVF@10% Cash flow PV of cashflow 0 1 $ (46,000.00) $     (46,000.00) 1 0.909 $   18,000.00 $        16,362.00 2 0.826 $   14,000.00 $        11,564.00 3 0.751 $   10,000.00 $          7,510.00 4 0.686 $      6,000.00 $          4,116.00 5 0.567 $      9,000.00 $          5,103.00 NVP $        (1,345.00) 3) Additional truck investment is not a good idea, because the net present value is negitive.

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