Bilboa Freightlines, S.A., of Panama, has a small truck that it uses for intraci
ID: 2534637 • Letter: B
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:
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 13% discount rate.
Click here to view Exhibit 13B-1 and Exhibit 13B-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?
3. Should Bilboa Freightlines keep the old truck or purchase the new one?
PresentTruck New
Truck Purchase cost new $ 30,000 $ 35,000 Remaining book value $ 20,000 - Overhaul needed now $ 19,000 - Annual cash operating costs $ 18,000 $ 19,000 Salvage value-now $ 5,000 - Salvage value-five years from now $ 5,000 $ 14,000
Explanation / Answer
NPV-Keep the old Truck: Annual operating cost -18000 Annuity factor f or 5 yrs at 13% 3.5172 Present value of outflows -63309.6 Present value of Overhauling -19000 Total present value of Outflows -82309.6 Less: Present value of salvage at end of 5yrs 2714 ($ 5000* PVF at 13% i.e. 0.5428) Net Present value -79595.6 NPV-Purchase of new truck: Annual operating cost -19000 Annuity factor f or 5 yrs at 13% 3.5172 Present value of outflows -66826.8 Initial Investment (35000-5000) -30000 Total present value of Outflows -96826.8 Less: Present value of salvage at end of 5yrs 7599.2 ($ 14000* PVF at 13% i.e. 0.5428) Net Present value -89227.6 Hence, the company shall keep the old truck.
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