Question

Problem 13-28 Net Present Value Analysis [LO13-2]

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	$	36,000		$	46,000
Remaining book value	$	26,000			-
Overhaul needed now	$	25,000			-
Annual cash operating costs	$	19,000		$	17,500
Salvage value-now	$	10,000			-
Salvage value-five years from now	$	12,000		$	11,000

    

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 10% discount rate.

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

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

Answer
1
	Now	1	2	3	4	5
Keep the old truck:
Overhaul needed now	$-25,000
Annual operating costs		$-19,000	$-19,000	$-19,000	$-19,000	$-19,000
Salvage value (old)						$    1,000
Total cash flows	$-25,000	$-19,000	$-19,000	$-19,000	$-19,000	$-18,000
Discount factor 10%	1	0.909	0.826	0.7513	0.683	0.621
Present value	$-25,000	$-17,271	$-15,694	$-14,275	$-12,977	$-11,178
Net present value	$-96,395
2
							Purchase the new truck:
	Now	1	2	3	4	5
Purchase new truck	$-46,000
Salvage value (old)	$ 10,000
Annual operating costs		$-17,500	$-17,500	$-17,500	$-17,500	$-17,500
Salvage value (new)						$ 11,000
Total cash flows	$-36,000	$-17,500	$-17,500	$-17,500	$-17,500	$    6,500
Discount factor 10%	1	0.909	0.826	0.7513	0.683	0.621
Present value	$-36,000	$-15,908	$-14,455	$-13,148	$-11,953	$    4,037
Net present value	$-87,426
3
Bilboa Freightlines should purchased the new truck
Answers might vary slightly due to rounding off