Jane’s Auto Care is considering the purchase of a new tow truck.
The garage doesn’t currently have a tow truck, and the $60,000
price tag for a new truck would represent a major expenditure. Jane
Austen, owner of the garage, has compiled the estimates shown below
in trying to determine whether the tow truck should be
purchased.
Initial cost | $60,000 | ||
Estimated useful life | 8 years | ||
Net annual cash flows from towing | $7,990 | ||
Overhaul costs (end of year 4) | $5,990 | ||
Salvage value | $12,000 |
Jane’s good friend, Rick Ryan, stopped by. He is trying to convince
Jane that the tow truck will have other benefits that Jane hasn’t
even considered. First, he says, cars that need towing need to be
fixed. Thus, when Jane tows them to her facility, her repair
revenues will increase. Second, he notes that the tow truck could
have a plow mounted on it, thus saving Jane the cost of plowing her
parking lot. (Rick will give her a used plow blade for free if Jane
will plow Rick's driveway.) Third, he notes that the truck will
generate goodwill; people who are rescued by Jane’s tow truck will
feel grateful and might be more inclined to use her service station
in the future or buy gas there. Fourth, the tow truck will have
“Jane’s Auto Care” on its doors, hood, and back tailgate—a form of
free advertising wherever the tow truck goes. Rick estimates that,
at a minimum, these benefits would be worth the
following.
Additional annual net cash flows from repair work | $3,010 | ||
Annual savings from plowing | 750 | ||
Additional annual net cash flows from customer “goodwill” | 970 | ||
Additional annual net cash flows resulting from free advertising | 740 |
The company’s cost of capital is 9%.
Question:
Calculate the net present value, incorporating the additional benefits suggested by Rick. (If the net present value is negative, use either a negative sign preceding the number eg -45 or parentheses eg (45). Round answer to 0 decimal places, e.g. 125. For calculation purposes, use 5 decimal places as displayed in the factor table provided.)
Solution :
Computation of NPV - Jane's Auto Care (Incorporating additional benefits) | ||||
Particulars | Amount | Period | PV Factor | Present Value |
Cash Outflows: | ||||
Initial investment in Truck | $60,000 | 0 | 1 | $60,000 |
Overhaul cost | $5,990 | 4 | 0.70843 | $4,243 |
Present Value of Cash Outflows (A) | $64,243 | |||
Cash Inflows: | ||||
Annual cash inflows from Towing | $7,990 | 1-8 | 5.53482 | $44,223 |
Additional annual net cash flows from repair work | $3,010 | 1-8 | 5.53482 | $16,660 |
Annual savings from plowing | $750 | 1-8 | 5.53482 | $4,151 |
Additional annual net cash flows from customer “goodwill” | $970 | 1-8 | 5.53482 | $5,369 |
Additional annual net cash flows resulting from free advertising | $740 | 1-8 | 5.53482 | $4,096 |
Salvage Value | $12,000 | 8 | 0.50187 | $6,022 |
Present Value of Cash Inflows (B) | $80,521 | |||
Net Present Value (B-A) | $16,278 |
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