Question

Door2DoorCo are a large courier company who have just received a shipment of X new vans. They wish to lock in a tyre supply contract to keep these vans well shod over the Y months that they intend to keep the vans. The vans come with low quality tyres that will need to be replaced in 2 months. Two suppliers, ThriftyTread and WiserWheels have expressed interest at supplying tyres at a fixed price for the duration. The offers are summarised below:

Number of Vans, X – 120

Corporate Discount rate – J1=12.68% p.a.

Initial Tyre Life – 2 months

Keep vans for (Y) – 50 months

ThriftyTread

• Tyre price - $100.00
• Tyre life – Four months
• Tyre replaced at – 2, 6, 10, …, 46, 50 months

WiserWheels

• Tyre price - $148.00
• Tyre life – Six months
• Tyres replaced at – 2, 8, 14, …, 44, 50 months

a) For each of the two potential suppliers, illustrate Door2DoorCO’s tyre expenditure for the new vans as a fully labelled timeline diagram. (Remember that there are X new vans, and assume each van has 4 tyres.)

b) Determine the value in period 2 dollars of the expenditure stream if Door2DoorCo decide to go with ThriftyTreads. [Hint, you will firstly need to find the j3 rate equivalent to the corporate discount rate, you will then need to find the PV of the expenditure stream in period 2 dollars]

c) Thus determine the present value of the expenditure stream if Door2DoorCo decide to go with ThriftyTreads. [NB this is a bit tricky and is aimed at stronger students]

d) Determine the value in period 2 dollars of the expenditure stream if Door2DoorCo decide to go with WiserWheels.

e) Thus determine the present value of the expenditure stream if Door2DoorCo decide to go with WiserWheels [NB this is a bit tricky and is aimed at stronger students]

f) Comparing your answers for part (b) with part (d), OR part (c) with part (e), explain which tyre supplier Door2DoorCo should choose.

g) Suggest three legitimate business considerations which a manager may take into account that might influence or even change the recommendation from part (f). NB “These tyres are prettier”, “This company will bribe me with a kickback”, or “My wife works for that company” are NOT legitimate business reasons. (Write around 20~30 words explaining/justifying each consideration.)

Answer 1

a) If the company has decided to buy tyres from ThriftyTread . Cost of tyres for months would be

Car require 4 tyres . Life of the car is 50 months , Tyres already with car which life is 2 months hence . Tyres required to be purchased for 48 months.

Here each tyre cost is $100 and life of tyres are 4 months , Hence we require to change tyres 12 times (=48/4(Total Months/life of tyres)

Hence , Total Tyres require = 12 x 4 x 120 nos = 5760 Nos (Car is four wheeler)  Total Cost of tyres each van = 5760 x $100= $576,000

Similarly , If purchase tyres from WiserWheels

Here life of tyres are 6 months , Hence company has purchase tyres 8 time (48/6), total tyres require = 8x4 x 120 = 3840 nos

Each tyre cost is $148 , Total cost would be = 3480 x $148 =$568,320.

Hence , from the above we say WiserWheels offer is better than offer of ThriftyTread.

b. if Door2Door decided to buy from ThriftyTread PV (Dollar ) value would be

As per hint we need to take discount rate as corporate discount rate .and we need to calculate Present Value of Period 2 to determined the dollar expenditure

Formula for present value is = Cash Flow /(1+Discount rate)^Period

Here , Cashflow would the cost of tyre i.e $100 each we require 480 (120 x 4) tyres in period 2 so total Cash flow = 480 x $100=$48000.

Hence PV =$48,000/(1+0.1268)²

= $48,000/(1.1268 )²

= $48,000/(1.1268 x 1.1268) =$37,804.85.

c)

Here if buy form ThriftyTread then company need to buy tyres 12 time ( refer calculation question a) hence here period would be 12 and Cashflow would be $576,000 , Discount Rate 12.68% or 0.1268

Hence PV =$576,000 /(1+0.1268)¹²

= $576000/(1.1268)¹²

= $576000/4.18949869777692

=$137486.

Note : We have to multiple 1.1268 by 1.1268 12 times to get the discount factor it will come  4.18949869777692

d. if Door2Door decided to buy from WiserWheels PV (Dollar ) value would be

As per hint we need to take discount rate as corporate discount rate .and we need to calculate Present Value of Period 2 to determined the dollar expenditure

Formula for present value is = Cash Flow /(1+Discount rate)^Period

Here , Cashflow would the cost of tyre i.e $148 each we require 480 (120 x 4) tyres in period 2 so total Cash flow = 480 x $148=$71040.

Hence PV =$$71,040/(1+0.1268)²

= $71,040/(1.1268 )²

= $71,040/(1.1268 x 1.1268) =$55,951.18

e)

Here if buy form WiserWheels then company need to buy tyres 8 time ( refer calculation question a) hence here period would be 8 and Cashflow would be $568,320 , Discount Rate 12.68% or 0.1268

Hence PV =$568,320 /(1+0.1268)⁸

= $568,320/(1.1268)⁸

= $568,320/4.18949869777692

=$135653.5.

Note : We have to multiple 1.1268 by 1.1268 12 times to get the discount factor it will come  4.18949869777692

f) If we compare the deal on basis on calculation of b and d , we will find ThriftyTread deals is cost effective than WiserWheels in period 2 . But we company PV of overall period (i.e. no c and e ) then WiserWheels deal is better.