Question
In: Finance
You are a financial analyst for a company that is developing a new resort in Hawaii...
You are a financial analyst for a company that is developing a new resort in Hawaii and the firm is in the process of purchasing 10 gold carts to carry potential condominium buyers around the property. You are choosing between one made by Club Car or one made by Yamaha. The two carts are judged to be similar in utility, but the Club Car is made more durably and is expected to have an effective working life of 5 years, compared to 4 for the Yamaha. Your firm’s tax rate is 35% and the required rate of return on this investment is 8%. Either one would be deprecated over its useful life to a salvage value of zero. At the end of their effective life, the carts will be donated to a local school system and so will have zero estimated salvage value. Which cart should the firm purchase? The following information is available:
Club Car:
Purchase price: $22,000
Annual Maintenance Expense: $1,900
Salvage Value at Life End: $0
Yamaha:
Purchase price: $19,000
Annual Maintenance Expense: $2,100
Salvage Value at Life End: $0
Solutions
Expert Solution
| Club Car: | Amount($) |
|
Purchase Purchase price: |
22,000.00 |
| Annual Maintenance Expense: | 1,900.00 |
| Salvage Value at Life End: | - |
| Working Life of the Car: | 5 years |
| Depreciation per year (22,000/5) : | 4,400.00 |
| Tax shiled on Deprecation (4,400*0.35) | 1,540.00 |
| After tax Annual Maintenance Expense (1900*0.65) | 1,235.00 |
| Total Cash Inflow from Club car for 5 years (1540-1235) | 305.00 |
| Equivalent Annual Cost of Club Car [22,000/PVIFA(8%,5) - 305] | 5,205.05 |
| Yamaha: | Amount($) |
|
Purchase Purchase price: |
19,000.00 |
| Annual Maintenance Expense: | 2,100.00 |
| Salvage Value at Life End: | - |
| Working Life of the Car: | 4 years |
| Depreciation per year (19,000/4) : | 1.00 |
| Tax shiled on Deprecation (4,750*0.35) | 1,662.50 |
| After tax Annual Maintenance Expense (2100*0.65) | 1,365.00 |
| Total Cash Inflow from Club car for 5 years (1662.50-1365) | 297.50 |
| Equivalent Annual Cost of Club Car [19,000/PVIFA(8%,4) - 297.50] | 5,439.04 |
.
Conclusion:
Firm should purchase Club Car as it has lower Equivalent Annual Cost as compared to Yahama. (5205.05<5439.04).
.
| Note: | |
| PVIFA(8%,5) | 3.9927 |
| PVIFA(8%,4) | 3.3121 |
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