Bilboa Freightlines, S.A., of Panama, has a small truck that it uses for intracity deliveries. The truck is worn out and must be either overhauled or replaced with a new truck. The company has assembled the following information:
Present Truck |
New Truck |
|||||
Purchase cost new | $ | 30,000 | $ | 35,000 | ||
Remaining book value | $ | 20,000 | - | |||
Overhaul needed now | $ | 19,000 | - | |||
Annual cash operating costs | $ | 18,000 | $ | 19,000 | ||
Salvage value-now | $ | 5,000 | - | |||
Salvage value-five years from now | $ | 5,000 | $ | 14,000 | ||
If the company keeps and overhauls its present delivery truck, then the truck will be usable for five more years. If a new truck is purchased, it will be used for five years, after which it will be traded in on another truck. The new truck would be diesel-operated, resulting in a substantial reduction in annual operating costs, as shown above.
The company computes depreciation on a straight-line basis. All investment projects are evaluated using a 13% discount rate.
Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using tables.
Required:
1. What is the net present value of the “keep the old truck” alternative?
2. What is the net present value of the “purchase the new truck” alternative?
3. Should Bilboa Freightlines keep the old truck or purchase the new one?
NPV-Keep the old Truck: | |||||
Annual operating cost | -18000 | ||||
Annuity factor f or 5 yrs at 13% | 3.5172 | ||||
Present value of outflows | -63309.6 | ||||
Present value of Overhauling | -19000 | ||||
Total present value of Outflows | -82309.6 | ||||
Less: Present value of salvage at end of 5yrs | 2714 | ||||
($ 5000* PVF at 13% i.e. 0.5428) | |||||
Net Present value | -79595.6 | ||||
NPV-Purchase of new truck: | |||||
Annual operating cost | -19000 | ||||
Annuity factor f or 5 yrs at 13% | 3.5172 | ||||
Present value of outflows | -66826.8 | ||||
Initial Investment (35000-5000) | -30000 | ||||
Total present value of Outflows | -96826.8 | ||||
Less: Present value of salvage at end of 5yrs | 7599.2 | ||||
($ 14000* PVF at 13% i.e. 0.5428) | |||||
Net Present value | -89227.6 | ||||
Hence, the company shall keep the old truck. | |||||
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