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	$	32,000		$	40,000
Remaining book value	$	19,000			-
Overhaul needed now	$	18,000			-
Annual cash operating costs	$	16,500		$	14,000
Salvage value-now	$	8,000			-
Salvage value-five years from now	$	7,000		$	6,000

    

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 11% 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

Answer- 1)-The net present value of the “keep the old truck” alternative =($74828).

2)- The net present value of the “purchase the new truck” alternative =($80182).

3)- Bilboa Freightlines should keep the old truck alternative.

Explanation-

Net Present Value (Purchase the New Truck)
Particulars	Cash Flows	Present Value Factor @11%	Present value
	(a)	(b)	(c=a*b)
Purchase New Truck (1st Year)	-40000	1	-40000
Salvage value (old)	8000	1	8000
Annual operating costs (5 years)	-14000	3.6959	-51743
Salvage value (new)	6000	0.5935	3561
Net Present Value			-80182
Bilboa Freightlines
Net Present Value (Keep the Old Truck)
Particulars	Cash Flows	Present Value Factor @11%	Present value
	(a)	(b)	(c=a*b)
Overhaul needed now	-18000	1	-18000
Salvage value (old)	7000	0.5935	4155
Annual operating costs (5 years)	-16500	3.6959	-60982
Net Present Value			-74828