Question

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	$	36,000		$	49,000
Remaining book value	$	24,000			-
Overhaul needed now	$	23,000			-
Annual cash operating costs	$	18,000		$	16,500
Salvage value-now	$	13,000			-
Salvage value-five years from now	$	10,000		$	8,000

    

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 9% 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?

Answer 1

PART A- NPV of "keep the old truck"

NPV = - Overhaul cost - [ Annual operating cost * PVAF (9%,5years) ] + PV of salvage value

= - $23,000 - ($18,000 * 3.89) + [ $10,000*0.65 ]

= - $86,520 (approx)

PART B- NPV of "Purchase value of new truck"

NPV = - Purchase cost of new truck + sales value of old truck - [ Annual operating cost * PVAF (9%,5years) ] + PV of salvage value

= - $49,000 + $13,000 - ($16,500 * 3.89) + (8,000 * 0.65)

= - $94,985 (approx)

PART C- DECISION

Bilboa freightlines should keep the old truck instead of purchasing the new one because the PV of cost of puchasing new truck is more than PV of cost of old truck

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