Question

very car that it uses for pizza deliveries. The he options are to either overhaul the car or replace it with a OpenStax Principles of Accounting, Volume 2: Managerial Accounts Chapter 11: Capital Budgeting Decisions PA8. LO 11.4 Pompeii's Pizza has a delivery car that it uses for p sion needs to be replaced and there are several other repairs that need to car is nearing the end of its life, so the options are to either over new car. Pompeii's has put together the following budgetary items: Present Car New Car Purchase cost new $31.000 Transmission and other repairs $ 8,500 Annual cash operating cost 12.500 10,000 Fair market value now 5,000 Fair market value in five years 500 5,000 mpeni 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 ven 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 za delivery vehicle. If they trade for the new delivery vehicle, their operating expenses will decrease because the new venicle is more gas efficient and the maintenance on a new car is less. This project is analyzed using a discount rate of 12%. What should Pompeii's do? Solution Cash Outflow for Transmission and other major repairs: $8.500 Cash 12% NPV of Year Outflows Factor Outflows Initial investment NPV of Cash Outflows Purchase New Vehicle 12% Factor NPV of Cash Outflows Cash Outflows Year Initial investment NPV of Cash Outflows Pompeii's should

Answer 1

Present car:

Year	Cash Outflows	12% Factor	NPV of Outflows
Initial investment	$8,500	1	$8,500
1	$12,500	0.89286	$11,161
2	$12,500	0.79719	$9,965
3	$12,500	0.71178	$8,897
4	$12,500	0.63552	$7,944
5	$12,000*	0.56743	$6,809
NPV of Cash Outflows			$53,276

*Annual cash operating cost - Fair market value in five years = $12,500-$500 = $12,000

New car:

Year	Cash Outflows	12% Factor	NPV of Outflows
Initial investment	$26,000*	1	$26,000
1	$10,000	0.89286	$8,929
2	$10,000	0.79719	$7,972
3	$10,000	0.71178	$7,118
4	$10,000	0.63552	$6,355
5	$5,000**	0.56743	$2,837
NPV of Cash Outflows			$59,211

*Cost of new car - fair market value of present car = $31,000-$5,000=$26,000

**Annual cash operating cost - Fair market value in five years = $10,000-$5,000 = $5,000

Decision:

Pompeii's should use present car because NPV of cash outflows is lower.