Question

Nancy’s Notions pays a delivery firm to distribute its products in the metro area. Delivery costs are $30,000 per year. Nancy can buy a used truck for $8,000 that will be adequate for the next 3 years. Operating and maintenance costs are estimated to be $20,000 per year. At the end of 3 years, the used truck will have an estimated salvage value of $3,000. Nancy’s MARR is 15%/year.
a. What is the present worth of investment
b. What is the decision rule for judging the attractiveness of investments based on present worth?|
c. Should Nancy buy the truck?

Answer 1

We have the following information

Life (n) = 3 years

MARR (i) = 15% or 0.15 per annum

Delivery Option

Net present worth (NPW) = Annual delivery cost(P/A, i, n)

NPW = 30,000(P/A, 15%, 3)

NPW = 30,000[((1+0.15)³ – 1)/0.15 (1+0.15)³]

NPW of Delivery Option = $68,496.75

Option of Buying Truck

NPW = Initial cost + Annual operating and maintenance cost(P/A, i, n) – Salvage value(P/F, i, n)

NPW = 8,000 + 20,000(P/A, 15%, 3) – 3,000(P/F, 15%, 3)

NPW = 8,000 + 20,000[((1+0.15)³ – 1)/0.15 (1+0.15)³] – 3,000/(1 + 0.15)³

NPW = 8,000 + 45,664.50 – 1,972.55

NPW =$51,691.95

Now, since the NPW of cost of Buying Truck option is less than the Delivery option, so Nancy’s Notion should buy the truck.