Question

The Department of Corrections (DOC) needs to replace two of its prison transport buses. There are two companies that have a track record of making reliable vehicles, and both make a bus that meets the needs of the department. The DOC pays an 8% interest rate on money it borrows. The bus from Company A has a purchase price of $105,000 and a 10-year service life expectancy, and it averages $2,000 per year in maintenance costs. The bus from Company B has a purchase price of $110,000 and a 10-year service life expectancy, and it averages $1,500 per year in maintenance costs. Which bus should the Department of Corrections select?

Answer 1

As bus from both companies have same service life, we can compare the present worth of costs associated with each bus to find which bus to select. Bus with lower present worth of costs should be selected.

Calculating present worth of costs of bus of Company A

Purchase price = $105000, Annual Maintenance costs = $2000, No of years of service = 10 years, Interest rate on loan = discount factor = 8%

Present worth of costs = Purchase price + Present value of Annual maintenance costs

We can find the present value of annual maintenance costs using PV function in excel

Formula to be used in excel: =PV(rate,nper,-pmt)

Using PV function in excel, we get present value of annual maintenance expenses = $13420.16

Present worth of costs of bus of company A = 105000 + 13420.16 = 118420.16

Calculating present worth of costs of bus of Company B

Purchase price = $110000, Annual Maintenance costs = $1500, No of years of service = 10 years, Interest rate on loan = discount factor = 8%

Present worth of costs = Purchase price + Present value of Annual maintenance costs

We can find the present value of annual maintenance costs using PV function in excel

Formula to be used in excel: =PV(rate,nper,-pmt)

Using PV function in excel, we get present value of annual maintenance expenses = $10065.12

Present worth of costs of bus of company B = 110000 + 10065.12 = 120065.12

Hence, Bus from Company A should be selected as it has lower present worth of costs as compared to bus from Company B

Answer : Bus from company A