Question

I need help with understanding how to set up step 2.

Chapter 6, Problem 3CP 3 Bookmarks Show all steps: ON СKG Auto compact car manufacturing assembly plants rely on parts from multiple outside vendors and internal subassembly plants. Currently, these parts are all transported via independent trucking firms for negotiated fees based on actual tons shipped and miles. The operations management group has been dissatisfied lately with the service levels provided by these outside trucking companies, as well as with the rising costs of roughly 6.0% per year for the last two years. These costs are expected to rise in the foreseeable future at similar rates, according to industry analysts. The operations management group is beginning a study to determine if purchasing or leasing a fleet of trucks would be a more cost-effective solution over the next seven years. To do so, the group has compiled some of the costs for each transport option, as follows: (1) Trucking by others-Using several different trucking carriers, the CKG Auto compact car manufacturing group currently pays $12,000,000 annually in trucking fees. Again, these costs are expected to rise at an annual rate of 6%. So in year 1, the cost is expected to be $12 million plus an additional 6%. All costs are considered expenses, which can be used to reduce income for purposes of calculating taxes. (2) Buying trucks-If СKG Auto purchased a fleet of 20 trucks, the cost of such a purchase would be based on the following: • The model of truck being considered with trailers is estimated to cost $125,000 per truck. This amount will be spent in year 0 (now). • This purchase would be funded using a bank loan. The bank is willing to lend the money at a 4.75% annual interest rate compounded quarterly over the next four years. A 10% down payment will be required, which can be funded from current assets. • The operations management group has been directed to assume that if CKG Auto purchases this fleet, it would be depreciated using straight line depreciation over the full seven-year period, assuming a salvage value of 8% of the original purchase price. • Operating costs for year 1 are estimated at $3.80 per mile; this includes driver wages, gas, insurance, maintenance, fees, and licenses. It is also assumed that each truck will average 150,000 miles per year. For year 2 and all subsequent years, assume a cost increase of 3.5% per year above the previous year . For the calculation of taxes, CKG Auto can deduct from each year's income the following: operating costs, the interest portion of the loan payments, and depreciation.

Answer 1

Particular	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7
Trucking fees - Paid to others	1,20,00,000	1,27,20,000	1,34,83,200	1,42,92,192	1,51,49,724	1,60,58,707	1,70,22,229
Cost	1,20,00,000	1,27,20,000	1,34,83,200	1,42,92,192	1,51,49,724	1,60,58,707	1,70,22,229
Buying Option
operating cost	1,14,00,000	1,17,99,000	1,22,11,965	1,26,39,384	1,30,81,762	1,35,39,624	1,40,13,511
Depreciation	3,57,143	3,57,143	3,57,143	3,57,143	3,57,143	3,57,143	3,57,143
Interest on Loan	1,08,794	1,14,054	1,19,569	1,25,351
	1,18,65,937	1,22,70,197	1,26,88,677	1,31,21,877	1,34,38,905	1,38,96,767	1,43,70,654
As per above workings, the cost as per trucking taken from others is more than Buying option. Hence it is recommend to go with Buying option.