Question

USE 3 DECIMAL DIGIT IN FACTOR

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 $ 34,000 $ 44,000 Remaining book value $ 21,000 - Overhaul needed now $ 20,000 - Annual cash operating costs $ 16,500 $ 15,000 Salvage value-now $ 10,000 - Salvage value-five years from now $ 9,000 $ 9,000 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 6% 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

1) NPV of the Keep the Old truck alternative

		0	1	2	3	4	5
	Investing cash flow(overhaul)	-20000
	Operating cash flow		-16500	-16500	-16500	-16500	-16500
	Salvage value						9000
	Depreciation		6400	6400	6400	6400	6400
	Total CF	-20000	-10100	-10100	-10100	-10100	-1100
NPV1	? -52,659.95

2. NPV of the Purchase the New Truck alternative

		0	1	2	3	4	5
	Investing cash flow	-44000
	Operating cash flow		-15000	-15000	-15000	-15000	-15000
	Salvage value of old truck	10000
	Salvage value of new truck						9000
	Depreciation		7000	7000	7000	7000	7000
	Total CF	-34000	-8000	-8000	-8000	-8000	1000
NPV2	? -57,522.25

Bilboa Freightlines should keep the old truck as the NPV was higher in this alternative.