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)	$	24,000		$	27,000
Remaining book value	$	8,000
Overhaul needed now	$	7,000
Annual cash operating costs	$	11,000		$	6,000
Salvage value-now	$	3,000
Salvage value-five years from now	$	2,000		$	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 18% discount rate.

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

1
	Now	1	2	3	4	5
Keep the old truck:
Overhaul needed now	-7000
Annual operating costs		-11000	-11000	-11000	-11000	-11000
Salvage value (old)						2000
Total cash flows	-7000	-11000	-11000	-11000	-11000	-9000
Discount factor 18%	1	0.847	0.718	0.609	0.516	0.437
Present value	-7000	-9317	-7898	-6699	-5676	-3933
Net present value	-40523
2
Purchase the new truck:
	Now	1	2	3	4	5
Purchase new truck	-27000
Salvage value (old)	3000
Annual operating costs		-6000	-6000	-6000	-6000	-6000
Salvage value (new)						5000
Total cash flows	-24000	-6000	-6000	-6000	-6000	-1000
Discount factor 18%	1	0.847	0.718	0.609	0.516	0.437
Present value	-24000	-5082	-4308	-3654	-3096	-437
Net present value	-40577
3
Bilboa Freightlines should keep the old truck