In: Accounting
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?
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