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 $ 36,000 $ 48,000
Remaining book value $ 23,000 -
Overhaul needed now $ 22,000 -
Annual cash operating costs $ 17,500 $ 16,000
Salvage value-now $ 12,000 -
Salvage value-five years from now $ 15,000 $ 6,000

    

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 9% discount rate.

Click here to view Exhibit 13B-1 and Exhibit 13B-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

Ans:

1.Keep Old: Now 1 2 3 4 5
Overhaul -22000
Annual operating costs -17500 -17500 -17500 -17500 -17500
Salvage 15000
Total cash flows -22000 -17500 -17500 -17500 -17500 -2500
Discount @9% 1 0.917 0.842 0.772 0.708 0.65
-22000 -16048 -14735 -13510 -12390 -1625
NPV -80308
2.Purchase New Now 1 2 3 4 5
Purchase cost -48000
Salvage old(will sold today) 0
Annual operating costs -16000 -16000 -16000 -16000 -16000
Salvage value 6000
Total cash flows -48000 -16000 -16000 -16000 -16000 -10000
Discount @9% 1 0.917 0.842 0.772 0.708 0.65
-48000 -14672 -13472 -12352 -11328 -6500
NPV -106324
3.Conclusion:
Since, present value of total costs in lower in case of keeping old rather than purchasing new and thus, it is better to retain the old machine


Hope this helped ! Let me know in case of any queries.

ekkarill92 answered 2 years ago
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