Question

2. A city has learned that by buying larger garbage trucks, it could reduce labor costs for garbage removal. Note: All the dollar amounts below are in this year’s dollars (constant dollars).

a. Cost of the trucks today is $400,000.

b. Annual savings in this year’s constant dollars is $90,000.

c. Trucks will last for 4 years and then will be sold for $100,000.

d. The city can borrow money at a 7% discount rate to purchase the trucks.

e. Inflation (for the next 4 years) is expected to average 3%.

f. Assuming the costs and benefits are incurred at the end of the year, should the city buy the trucks?

Answer 1

The city should buy the trucks since NPV is positive.

	Option 1
Year	Initial cost	Annual savings	Salvage	Net cash flows
0	-400000			-400000
1		92700		92700
2		95481		95481
3		98345.43		98345.43
4		101295.7929	112550.881	213846.6739
			NPV	13454.09

WORKINGSNotes: Annual savings and salvage is shown at inflated values.