Question

*Please make sure to round discount factor to 3rd decima place as listed*

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		$	31,000
Remaining book value	$	12,000			-
Overhaul needed now	$	8,000			-
Annual cash operating costs	$	13,000		$	10,500
Salvage value-now	$	6,000			-
Salvage value-five years from now	$	5,000		$	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 14% discount rate.

Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using tables.

    

Required:

1-a.	Use the total-cost approach to net present value. (Any cash outflows should be indicated by a minus sign. Round discount factor(s) to 3 decimal places.)
	1-b. Should Bilboa Freightlines keep the old truck or purchase the new one? 1-b. Purchase the new truck Keep the old truck

Answer 1

1a. Net present value is as computed below:

Present Truck	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Total
Overhaul Needed now	($8,000)						-8,000
Annual cash operating costs		-13,000	-13,000	-13,000	-13,000	-13,000	-65,000
Salvage value						5,000	5,000
Total cash outflow	($8,000)	($13,000)	($13,000)	($13,000)	($13,000)	($8,000)	-68,000
Rate 14%
Time 5 years
	1.00	0.88	0.77	0.67	0.59	0.52
Present Value	-8,000	-11,404	-10,003	-8,775	-7,697	-4,155	-50,033
New Truck	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Total
Purchase of new truck	-31,000
Sale of old truck	$6,000						6,000
Annual cash operating costs		-10,500	-10,500	-10,500	-10,500	-10,500	-52,500
Salvage value						6,000	6,000
Total cash outflow	($25,000)	($10,500)	($10,500)	($10,500)	($10,500)	($4,500)	-71,500
Rate 14%
Time 5 years
	1.00	0.88	0.77	0.67	0.59	0.52
Present Value	-25,000	-9,211	-8,079	-7,087	-6,217	-2,337	-57,931

1b.  Bilboa Freightlines should keep the old truck.