Jane’s Auto Care is considering the purchase of a new tow truck. The garage does

Question

Jane’s Auto Care is considering the purchase of a new tow truck. The garage doesn’t currently have a tow truck, and the $60,020 price tag for a new truck would represent a major expenditure. Jane Austen, owner of the garage, has compiled the estimates shown below in trying to determine whether the tow truck should be purchased.
Initial cost $60,020 Estimated useful life 8 years Net annual cash flows from towing $7,960 Overhaul costs (end of year 4) $5,980 Salvage value $12,000
Jane’s good friend, Rick Ryan, stopped by. He is trying to convince Jane that the tow truck will have other benefits that Jane hasn’t even considered. First, he says, cars that need towing need to be fixed. Thus, when Jane tows them to her facility, her repair revenues will increase. Second, he notes that the tow truck could have a plow mounted on it, thus saving Jane the cost of plowing her parking lot. (Rick will give her a used plow blade for free if Jane will plow Rick's driveway.) Third, he notes that the truck will generate goodwill; people who are rescued by Jane’s tow truck will feel grateful and might be more inclined to use her service station in the future or buy gas there. Fourth, the tow truck will have “Jane’s Auto Care” on its doors, hood, and back tailgate—a form of free advertising wherever the tow truck goes. Rick estimates that, at a minimum, these benefits would be worth the following.
Additional annual net cash flows from repair work $3,010 Annual savings from plowing 750 Additional annual net cash flows from customer “goodwill” 960 Additional annual net cash flows resulting from free advertising 740
The company’s cost of capital is 9%.

Click here to view PV table.

Explanation / Answer

(a)

Calculate the net present value, ignoring the additional benefits described by rick

Particulars

Cash flows

PV factor

Present value

Present value of net annual cash flows

7960

5.5348

44057

Present value of cost of overhaul

-5980

0.7084

-4236

Present value of salvage value

12000

0.5018

6022

45842

Investment

60020

Net present value

-14178

Truck should not be purchased, because NPV is negative

(b)

Calculate the net present value, incorporating the additional benefits described by rick

Particulars

Cash flows

PV factor

Present value

Present value of net annual cash flows

13420

5.5348

74277

Present value of cost of overhaul

-5980

0.7084

-4236

Present value of salvage value

12000

0.5018

6022

76062

Investment

60020

Net present value

16042

3010+750+960+740+7960 =13420

Truck should be purchased because NPV is positive

[c]

Suppose rick has been very optimistic in his assesement of value

             The net intangible benefit is 30220. rick should incorporate additional benefits to get project acceptable. rick estimation might be overly optimistic

(a)

Calculate the net present value, ignoring the additional benefits described by rick

Particulars

Cash flows

PV factor

Present value

Present value of net annual cash flows

7960

5.5348

44057

Present value of cost of overhaul

-5980

0.7084

-4236

Present value of salvage value

12000

0.5018

6022

45842

Investment

60020

Net present value

-14178

Truck should not be purchased, because NPV is negative

(b)

Calculate the net present value, incorporating the additional benefits described by rick

Particulars

Cash flows

PV factor

Present value

Present value of net annual cash flows

13420

5.5348

74277

Present value of cost of overhaul

-5980

0.7084

-4236

Present value of salvage value

12000

0.5018

6022

76062

Investment

60020

Net present value

16042

3010+750+960+740+7960 =13420

Truck should be purchased because NPV is positive

[c]

Suppose rick has been very optimistic in his assesement of value

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