Question

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)	$	25,000		$	30,000
Remaining book value	$	11,000
Overhaul needed now	$	11,000
Annual cash operating costs	$	12,500		$	10,000
Salvage value-now	$	5,000
Salvage value-five years from now	$	4,000		$	5,000

    

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 11% discount rate.

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?

Answer 1

In the above answer discount factor indicates that the present value of ordinary annuity at 11% for 5 peridos and present value factor at 11% for 5 years .