Question

Bilboa Freightlines, S.A. of Panama has a small truck that it uses for local deliveries. The truck is in bad repair and must be either overhauled or replaced with a new truck. The company has assembled the following information (Panama uses the U.S. dollar as its currency):

	Present Truck			New Truck
Purchase cost new	$	41,000		$	55,000
Remaining book value		26,000			-
Overhaul needed now		8,000			-
Annual cash operating costs		11,000			8,500
Salvage value now		14,000			-
Salvage value eight years from now		1,000			4,000

  

If the company keeps and overhauls its present delivery truck, then the truck will be usable for eight more years. If a new truck is purchased, it will be used for eight years, after which it will be traded in on another truck. The new truck would be diesel-fuelled, 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 16% discount rate.

    

Click here to view Exhibit 10-1 and Exhibit 10-2, to determine the appropriate discount factor(s) using tables.

  

Required:

1-a.	Determine the present value of net cash flows using the total-cost approach. (Negative amounts should be indicated with a minus sign. Round discount factor(s) to 3 decimal place.)

  
        

  

1-b.	Should Bilboa Freightlines keep the old truck or purchase the new one?
	Purchase the new truck Keep the old truck

2.	Using the incremental-cost approach, determine the net present value in favor of (or against) purchasing the new truck? (Negative amounts should be indicated with a minus sign. Round discount factor(s) to 3 decimal place.)

    
        

Answer 1

Solution 1a:

Total cost approach to Net Present Value - Bilboa Freighlines
Particulars	Now	1	2	3	4	5	6	7	8
Keep the old truck:
Overhaul needed now	-$8,000.00
Annual operating costs		-$11,000.00	-$11,000.00	-$11,000.00	-$11,000.00	-$11,000.00	-$11,000.00	-$11,000.00	-$11,000.00
Salvage value (Old)									$1,000.00
Total cash flows	-$8,000.00	-$11,000.00	-$11,000.00	-$11,000.00	-$11,000.00	-$11,000.00	-$11,000.00	-$11,000.00	-$10,000.00
Discount factor 16%	1.000	0.862	0.743	0.641	0.552	0.476	0.410	0.354	0.305
Present Value	-$8,000.00	-$9,482.00	-$8,173.00	-$7,051.00	-$6,072.00	-$5,236.00	-$4,510.00	-$3,894.00	-$3,050.00
Net Present Value	-$55,468.00
Purchase the New Truck:
Purchase new truck	-$55,000.00
Salvage value (old)	$14,000.00
Annual operating costs		-$8,500.00	-$8,500.00	-$8,500.00	-$8,500.00	-$8,500.00	-$8,500.00	-$8,500.00	-$8,500.00
Salvage value (new)									$4,000.00
Total cash flows	-$41,000.00	-$8,500.00	-$8,500.00	-$8,500.00	-$8,500.00	-$8,500.00	-$8,500.00	-$8,500.00	-$4,500.00
Discount factor 10%	1.000	0.862	0.743	0.641	0.552	0.476	0.410	0.354	0.305
Present Value	-$41,000.00	-$7,327.00	-$6,315.50	-$5,448.50	-$4,692.00	-$4,046.00	-$3,485.00	-$3,009.00	-$1,372.50
Net Present Value	-$76,695.50

Solution 1b:

Present value of cash outflows under keeping old truck is lower than present value of cash outlflow in buying new truck, therefore company should keep the old truck.

Solution 2:

Computation of NPV - Replacemen decision - Bilboa Freightlines (Incremental Approach)
Particulars	Amount	Period	PV Factor	Present Value
Cash Outflows:
Initial investment in New Truck	$55,000	0	1	$55,000
Salvage value of old truck	-$14,000	0	1	-$14,000
Saving in overhaul cost	-$8,000	0	1	-$8,000
Present Value of Cash Outflows (A)				$33,000
Cash Inflows:
Annual savings in cash operating cost	$2,500	1-8	4.343	$10,858
Incremental salvage value	$3,000	8	0.305	$915
Present Value of Cash Inflows (B)				$11,773
Net Present Value (B-A)				-$21,228