Question

Penguin Inc. is a company that provides refrigerated transportation for perishable products. The firm is concerned about the high costs it faces due to the amount of produce it loses during transportation as well as the fuel costs. Therefore, it is currently considering the purchase of a high-tech refrigeration vehicle which is energy efficient, environmentally friendly and will also reduce the loss of produce significantly. The vehicle (a truck) has a useful life of 8 years. If purchased, this truck will reduce total costs by 3% per year for the next three years. Thereafter, it will lose efficiency due to wear-and-tear. The truck will still help reduce total costs, but by only 1% for the remaining 5 years. The machine will be scrapped at the end of the 8th year. (Assume that the scrap value of the truck is zero.) The current transportation costs of the company are $10 million per year and the annual interest rate is 6%. (5pts) (a) What is the present value of the transportation costs the firm faces for the next 8 years if the firm does not purchase the truck? (10pts) (b)What is the present value of the transportation costs if this truck is purchased? Draw a timeline. (5pts) (c) How much will the firm save in terms of transportation costs if it purchases the truck? Should the company purchase this truck if it will cost $ 4 million today? Explain why or why not.

Answer 1

Ans a) 73600870.51

		Y1	Y2	Y3	Y4	Y5	Y6	Y7	Y8	Y9	Y10
1	Transportation Costs	10000000	10000000	10000000	10000000	10000000	10000000	10000000	10000000	10000000	10000000
2	Interest Rate 6%
3	PV =	10M/1.06	10M/1.06^2	10M/1.06^3	10M/1.06^4	10M/1.06^5	10M/1.06^6	10M/1.06^7	10M/1.06^8	10M/1.06^9	10M/1.06^10
4	PV at 6%	9433962.264	8899964.4	8396192.83	7920936.632	7472581.729	7049605.404	6650571.136	6274123.713	5918984.635	5583947.769
5	PV = Sum of 4	73600870.51

Ans b) 72330259.42

		Y1	Y2	Y3	Y4	Y5	Y6	Y7	Y8	Y9	Y10
1	Transportation Costs	9700000	9700000	9700000	9900000	9900000	9900000	9900000	9900000	9900000	9900000
2	Interest Rate 6%
3	PV =	10M/1.06	10M/1.06^2	10M/1.06^3	10M/1.06^4	10M/1.06^5	10M/1.06^6	10M/1.06^7	10M/1.06^8	10M/1.06^9	10M/1.06^10
4	PV at 6%	9150943.396	8632965.47	8144307.05	7841727.266	7397855.911	6979109.35	6584065.425	6211382.476	5859794.789	5528108.291
5	PV = Sum of 4	72330259.42

Ans c) Company can save 1,270,611 if they purchase the truck.

Yes company should replace the truck as they are saving above 1 million in term of present value and as they are into transportation business, loosing money due to poor transportation and high cost. New machine would also give them competitive advantage.

However decision also depend on the cost of new vehicle. If cost is very high and NPV turns negative than they shouldn't buy.

Hope this helps