Question

Pompeii's Pizza has a delivery car that it uses for pizza deliveries. The transmission needs to be replaced and there are several other repairs that need to be done. The car is nearing the end of its life, so the options are to either overhaul the car or replace it with a new car. Pompeii's has put together the following budgetary items:

	Present Car	New Car
Purchase cost new		$32,000
Transmission and other repairs	$8,000
Annual cash operating cost	12,000	11,000
Fair market value now	5,000
Fair market value in five years	500	5,000

If Pompeii’s replaces the transmission of the pizza delivery vehicle, they expect to be able to use the vehicle for another 5 years. If they sell the old vehicle and purchase a new vehicle, they will use that vehicle for 5 years and then trade it in for another new pizza delivery vehicle. If they trade for the new delivery vehicle, their operating expenses will decrease because the new vehicle is more gas efficient and the maintenance on a new car is less. This project is analyzed using a discount rate of 10%.

Answer 1

To analyse the project, we will have to compare the cost related to both the options.

Option I : Make repairs to present car

Cost of the project = Transmission and other repair charges + PV of annual operating cost - PV of vehicle after 5 years

= $8,000 + ($12,000 * 3.791) - ($500 * 0.621)

= $8,000 + $45,492 - $310.50

= $53,181.50

Option II : Purchase new car

Cost of the project = Purchase cost of the new car - Proceeds from the sale of old car + PV of annual operating cost - PV of new car after 5 years

= $32,000 - $5,000 + ($11,000 * 3.791) - ($5,000 * 0.621)

= $27,000 + $41,701 - $3,105

= $65,596

Conclusion : After analyzing the costs involved in both the options, we can conclude that it is better to make necessary repairs to the present vehicle available with the Pompeii's Pizza instead of replacing the vehicle.