Question

Bilboa Freightlines, SA, of Panama, has a small truck that it uses for intracity deliveries. The truck is worn out and must be ether overhauled or replaced with a new truck. The company has assembled the following information 28,889 15,00 538,00 $ Purchase cost (new) Remaining book value Overhaul needed now Annual cash operating costs Salvage value- Salvage value-five years from now $ 14,5ee $ 13, $ 18, $9.99 $123 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 abowe. The company computes depreciation on a straight-line basis. All investment projects are evaluated using a 13% discount rate. Click here to view Exhibit 120.1 and Exhibit 128-2. to determine the appropriate discount factors) 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

1) Net Cash outflows(Assumed Tax Rate is 30%) Tax Savings on Cash Year Operating Expenses Depreciation(Note 1) Expenses@30% C=A*30% 14500 4000 14500 4000 14500 4000 14500 4000 14500 4000 Tax Savings on Depreciation Net Cash @30% outflows D=B*30% E=A-C-D 4350 1200 8950 4350 1200 8950 4350 1200 8950 4350 1200 4350 1200 8950 8950 Amount Depreciation( Note 1) Sno Particulars 1 Remaining Book Value 2 Overhaul needed now 3 Asset Value(1+2) 4 salvage Value 5 Number of years 6 Depreciation(3-4)/5 15000 14000 29000 9000 4000

Net Present Value of outflows Sno N et Cash outflows Discount Factor@13% Present Value of outflow 14000 14000 8950 0.885 7920.354 8950 0.783 7009.163 8950 0.693 6202.799 8950 0.613 5489.203 8950 0.543 4857.701 Net Present Value of outflows 45479 Note: Overhaul is 14000

2) Net Cash outflows(Assumed tax rate is 30%) Tax Savings on Cash Year Operating Expenses Depreciation(Note 1) Expenses@30% C=A*30% 13000 5200 13000 5200 13000 5200 13000 5200 13000 5200 Tax Savings on Depreciation Net Cash @30% outflows D=B*30% E=A-C-D 3900 1560 7540 3900 7540 3900 7540 3900 7540 3900 1560 7540 15600 1560 mi 1560 Amount Depreciation( Note 2) Sno Particulars 1 Purchase Cost 2 salvage Value 3 Number of years 4 Depreciation(1-2)/3 38000 12000 5200

Net Present Value of outflows Sno N et Cash outflows Discount Factor@13% Present Value of outflow (Note3)0 28000 28000 7540 0.885 6672.566 7540 0.783 5904.926 7540 0.693 5225.598 7540 0.613 4624.423 7540 0.543 4092.410 Net Present Value of outflows 54520 Note3 In case if you buy new truck then sale value from old truck is 10000 thus New truck buy out flow is =38000-10000 Outflow new truck= 28000 3 Decision It is better to continue with old truck as present value outflow is lower