Question

Please answer question 3.

2. A city has learned that by buying larger garbage trucks, it could reduce labor costs for garbage removal. Note: All the dollar amounts below are in this year’s dollars (constant dollars). a. Cost of the trucks today is $400,000. b. Annual savings in this year’s constant dollars is $90,000. c. Trucks will last for 4 years and then will be sold for $100,000. d. The city can borrow money at a 7% discount rate to purchase the trucks. e. Inflation (for the next 4 years) is expected to average 3%. f. Assuming the costs and benefits are incurred at the end of the year, should the city buy the trucks?

3. This assignment extends the garbage truck problem from prompt 2. Two other lenders provide alternative scenarios. Alternate lender 1 suggests that the inflation rate will be 4% and offers an interest rate of 7.5%, while alternate lender 2 suggests that the inflation rate will be 1% and offers an interest rate of 6.5%. For all three sources, the interest rates are guaranteed if the decision is made in the next 90 days. Which of the following decisions should be made and why?

a. The usual lender should be used because she offers a positive NPV.

b. Alternate lender 1 should be used because he offers the highest NPV.

c. The garbage trucks shouldn’t be purchased because there is a possibility of a negative NPV.

d. Alternate lender 2 should be used because most scenarios have a positive NPV and she offers the highest NPV under each scenario.

e. Each solution is as good as any other.

Answer 1

3. The answer is b.Alternate lender 1 should be used because he offers the highest NPV.

We need to calculate NPV for all the 3 scenarios.

Scenario 1: Usual lender

Calculation of NPV

Years	0	1	2	3	4
Cost of truck	-$400,000	$0	$0	$0	$0
Annual savings	$90,000	$92,700	$95,481	$98,345	$101,296
Salvage value	$0	$0	$0	$0	$100,000
Cash flows	-$400,000	$92,700	$95,481	$98,345	$201,296
NPV	$3,879.08

Formulas

Scenario 2: Alternate 1 lender

Calculation of NPV

Years	0	1	2	3	4
Cost of truck	-$400,000	$0	$0	$0	$0
Annual savings	$90,000	$93,600	$97,344	$101,238	$105,287
Salvage value	$0	$0	$0	$0	$100,000
Cash flows	-$400,000	$93,600	$97,344	$101,238	$205,287
NPV	$6,516.33

Formulas

Scenario 3: Alternate 2 lender

Calculation of NPV

Years	0	1	2	3	4
Cost of truck	-$400,000	$0	$0	$0	$0
Annual savings	$90,000	$90,900	$91,809	$92,727	$93,654
Salvage value	$0	$0	$0	$0	$100,000
Cash flows	-$400,000	$90,900	$91,809	$92,727	$193,654
NPV	-$6,407.59

Formulas

From the above NPV calculations of 3 scenarios, we can see that Alternate 1 has the highest NPV of $6,516.33. So alternate 1 lender should be used to purchase the truck.