Question

Your company operates a bulldozer that is several years old, and needs to be repaired frequently. You estimate that you can run it for only two more years, and that if you do, it will generate cash flows of $5,000 next year and $5,000 in the year after that. If you trade in the old bulldozer (forgoing these cashflows) and purchase a new one for $50,000 (the balance owing after the trade in allowance), you estimate the new one will generate cash flows in the next four years of $12,000, $14,000, $16,000 and $20,000, at which time the new bulldozer will be taken out of service and sold for $5,000. Is the purchase of the new bulldozer financially justified if the appropriate discount rate is 8%? (Assume all cash flows occur at the end of the year )
Select one:
a. Yes, it generates a positive NPV of $4,191.
b. Yes, it generates a positive NPV of $516.
c. No, it generates a negative NPV of $4,725.
d. No, it generates a negative NPV of $8,401.
e. None of the above.

Answer 1

This question can be solved by computing the NPV for incremental cashflows.

Incremental operating cashflows

Year	1	2	3	4
Cashflows from old bulldozer	5,000.00	5,000.00	-	-
Cashflows from new bulldozer	12,000.00	14,000.00	16,000.00	20,000.00
Incremental cashflows (cashflows from new bulldozer - cashflows from old bulldozer)	7,000.00	9,000.00	16,000.00	20,000.00

Incremental Terminal cashflows

Sale value of new bull dozer

5,000.00

Cashflow table

Year	0	1	2	3	4
Incremental cost of equipment	(50,000.00)
Incremental operating cashflows - refer above table		7,000.00	9,000.00	16,000.00	20,000.00
Incremental terminal cashflows					5,000.00
Net incremental cashflows (sum of above cashflows)	(50,000.00)	7,000.00	9,000.00	16,000.00	25,000.00
PV factor @ 8% --> Formua ---> 1/(1+8%)^nth year	1.0000	0.9259	0.8573	0.7938	0.7350
PV cashflows (Net incremental cashflows x PV factor)	(50,000.00)	6,481.48	7,716.05	12,701.32	18,375.75
NPV	(4,725)

Therefore answer is option c - No, it generates a negative NPV of $ 4725.

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