Question

Bilboa Freightlines, S.A., of Panama, has a small truck that it uses for intracity deliveries. The truck is worn out and must be either overhauled or replaced with a new truck. The company has assembled the following information: New Truck $ 30,000 Purchase cost (new) Remaining book value Overhaul needed now Annual cash operating costs Salvage value-now Salvage value-five years from now Present Truck $ 21,000 $ 11,500 $ 7,000 $ 10,000 $ 9,000 $ 1,000 $ 6,500 $ 4,000 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 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 12B-1 and Exhibit 12B-2, to determine the appropriate discount factor(s) 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?

Answer 1

1
	Now	1	2	3	4	5
Keep the old truck:
Overhaul needed now	-7000
Annual operating costs		-10000	-10000	-10000	-10000	-10000
Salvage value (old)						1000
Total cash flows	-7000	-10000	-10000	-10000	-10000	-9000
Discount factor 16%	1	0.862	0.743	0.641	0.552	0.476
Present value	-7000	-8620	-7430	-6410	-5520	-4284
Net present value	-39264
2
Purchase the new truck:
	Now	1	2	3	4	5
Purchase new truck	-30000
Salvage value (old)	9000
Annual operating costs		-6500	-6500	-6500	-6500	-6500
Salvage value (new)						4000
Total cash flows	-21000	-6500	-6500	-6500	-6500	-2500
Discount factor 16%	1	0.862	0.743	0.641	0.552	0.476
Present value	-21000	-5603	-4829.5	-4166.5	-3588	-1190
Net present value	-40377