Jane’s Auto Care is considering the purchase of a new tow truck. The garage does
ID: 2658091 • Letter: J
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 $59,960 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.
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.
The company’s cost of capital is 9%.
a)calculate the net present value ignoring the additonal benefits described by Rick. Should the tow truck be purchased.
b) Calculate the net present value incorporating the additonal benefits suggested by Rick. Should the tow truck be purchased
c) Suppose rick hs been overly optimistic in his assessement of the value of additional benefits. At minimum how would the additonal benefits have to be worth in order for the project to be accepted.
Initial cost $59,960 Estimated useful life 8 years Net annual cash flows from towing $7,980 Overhaul costs (end of year 4) $5,960 Salvage value $11,990Explanation / Answer
a) Year 0 1 2 3 4 5 6 7 8 Net Annual Cash Flow 7980 7980 7980 7980 7980 7980 7980 7980 Overhaul costs 5960 Salvage Value 11990 Initial Price 59960 Net Cash Flow -59960 7980 7980 7980 2020 7980 7980 7980 19970 NPV @ 9% -13996.98 Since NPV is negative, so project should not be taken b) Additional annual cash flow (3000+760+1000+740) 5500 Year 0 1 2 3 4 5 6 7 8 Net Annual Cash Flow 7980 7980 7980 7980 7980 7980 7980 7980 Overhaul costs 5960 Additional annual cash flow 5500 5500 5500 5500 5500 5500 5500 5500 Salvage Value 11990 Initial Price 59960 Net Cash Flow -59960 13480 13480 13480 7520 13480 13480 13480 25470 NPV @ 9% 16444.52 Since NPV is positive, so project should not be taken c) Critical value of additional benefits 2528.9
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