Question

In: Accounting

Bilboa Freightlines, S.A., of Panama, has a small truck that it uses for intracity deliveries. The...

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) $ 28,000 $ 38,000 Remaining book value $ 15,000 Overhaul needed now $ 14,000 Annual cash operating costs $ 14,500 $ 13,000 Salvage value-now $ 10,000 Salvage value-five years from now $ 9,000 $ 12,000 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 13% discount rate. Click here to view Exhibit 12B-1 and Exhibit 12B-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?

Solutions

Expert Solution

Answer:

YEAR 0 1 2 3 4 5

1) Keep the old truck

Overhaul needed now -14000
Annual Operating Cost 0 -14500 -14500 -14500 -14500 -14500
Salvage Value after 5 years 9000
Total Cash Flows -14000 -14500 -14500 -14500 -14500 -5500
Discount Factor -13% 1 0.885 0.783 0.693 0.613 0.543
Present Value -14000 -12832.5 -11353.5 -10048.5 -8888.5 -7873.5
Net Present Value $ (64997)

2) Purchase New truck

Cost of new truck -38000
Salvage Value Old if sold now 10000
Annual Operating Cost 0 -13000 -13000 -13000 -13000 -13000
Salvage Value New 12000
Total Cash Flows -28000 -13000 -13000 -13000 -13000 -1000
Discount Factor - 13% 1 0.885 0.783 0.693 0.613 0.543
Present Value -28000 -11505 -10179 -9009 -7969 -7059
Net Present Value $ (73721)

3) Decision - The Company Should Keep the old truck.

Working Note:  Cost Of Capital for each year is 13%

1 , 0.885 , 0.783 , 0693 , 0.613 , 0.543 for 5 years

ekkarill92 answered 1 year ago
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