Question

Jane’s Auto Care is considering the purchase of a new tow truck. The garage doesn’t currently have a tow truck, and the $60,050 price tag for a new truck would represent a major expenditure. Jane Austen, owner of the garage, has compiled the estimates shown below in trying to determine whether the tow truck should be purchased. Initial cost $60,050 Estimated useful life 8 years Net annual cash flows from towing $8,010 Overhaul costs (end of year 4) $5,970 Salvage value $12,010 Jane’s good friend, Rick Ryan, stopped by. He is trying to convince Jane that the tow truck will have other benefits that Jane hasn’t even considered. First, he says, cars that need towing need to be fixed. Thus, when Jane tows them to her facility, her repair revenues will increase. Second, he notes that the tow truck could have a plow mounted on it, thus saving Jane the cost of plowing her parking lot. (Rick will give her a used plow blade for free if Jane will plow Rick's driveway.) Third, he notes that the truck will generate goodwill; people who are rescued by Jane’s tow truck will feel grateful and might be more inclined to use her service station in the future or buy gas there. Fourth, the tow truck will have “Jane’s Auto Care” on its doors, hood, and back tailgate—a form of free advertising wherever the tow truck goes. Rick estimates that, at a minimum, these benefits would be worth the following. Additional annual net cash flows from repair work $2,990 Annual savings from plowing 760 Additional annual net cash flows from customer “goodwill” 1,000 Additional annual net cash flows resulting from free advertising 750 The company’s cost of capital is 9%. Calculate the net present value, incorporating the additional benefits suggested by Rick. (If the net present value is negative, use either a negative sign preceding the number e.g. -45 or parentheses e.g. (45). Round answer to 0 decimal places, e.g. 125. For calculation purposes, use 5 decimal places as displayed in the factor table provided.) Net present value $Type your answer here Should the tow truck be purchased?

Answer 1

Solution:

Computation of NPV - Jane's Auto Care (Incorporating additional benefits)
Particulars	Amount	Period	PV Factor	Present Value
Cash Outflows:
Initial investment in Truck	$60,050	0	1	$60,050
Overhaul cost	$5,970	4	0.70843	$4,229
Present Value of Cash Outflows (A)				$64,279
Cash Inflows:
Annual cash inflows from Towing	$8,010	1-8	5.53482	$44,334
Additional annual net cash flows from repair work	$2,990	1-8	5.53482	$16,549
Annual savings from plowing	$760	1-8	5.53482	$4,206
Additional annual net cash flows from customer “goodwill”	$1,000	1-8	5.53482	$5,535
Additional annual net cash flows resulting from free advertising	$750	1-8	5.53482	$4,151
Salvage Value	$12,010	8	0.50187	$6,027
Present Value of Cash Inflows (B)				$80,803
Net Present Value (B-A)				$16,524

As NPV is postitve, therefore Tow truck should be purchased.