Question

Kings Taxi Service is currently operating a truck-hire service in Honiara. It is considering the replacement of a 1.5 tonne vehicle with a 2-tonne vehicle. Details of the respective vehicles are as follows:

1.5 tonne vehicle	2 tonne vehicle
Remaining life: 4 years Residual value: Now: $4,000 In 4 years: $0 Annual net cash flows:   $6,000	Estimated life: 7 years Cost: $15,000 Residual value: $1,000 Annual net cash flow: $10,000

Other information is as follows:

• Net cash flow are to be regarded as received end of each year
• The required rate of return is 10% per annum
• Management is considering the following alternatives:

1. Replace the 1.5 tonne vehicle now
2. Replace the 1.5 tonne vehicle in 4 years time

Required: Advice the management of Kings Taxi Service as to which alternative it should adopt and justify your analysis

Answer 1

Alternative 1 Use of 1.5 Tonne vehicle now
Year	Annual Net cash flow	Present value fator @10%	Present value
1	6,000	0.909	5,454
2	6,000	0.826	4,956
3	6,000	0.751	4,506
4	6,000	0.683	4,098
Net Present value	19,014
Alternative 2 Purchase of 2.0 Tonne Vehicle now
Year	Annual Net cash flow	Present value fator @10%	Present value
1	10,000	0.909	9,090
2	10,000	0.826	8,260
3	10,000	0.751	7,510
4	10,000	0.683	6,830
5	10,000	0.621	6,210
6	10,000	0.564	5,640
7	11,000	0.513	5,643
P.V of annual cash flows	49,183
Less:	P.v of Cash Inflows (15000-4000)		11,000
Net present value	38,183
Decision:- Since purchase of 2 tonne truck gives a Positive NPV. Therefore we should purchase a 2.0 tonne vehicle & Replace the 1.5 tonne vehicle