Southport Transport plans on purchasing a bus for dollar 75,000 that will have a
ID: 2730668 • Letter: S
Question
Southport Transport plans on purchasing a bus for dollar 75,000 that will have a capacity of 40 passengers. As an alternative, a larger bus can be purchased for dollar 95,000 that will have a capacity of 50 passengers. The salvage value of the smaller bus is estimated to be dollar 8,000 after a 10-year life. The salvage value of the larger bus is estimated to be dollar 12,000 after a 10-year life. If an annual earnings (ticket sales - operating expenses) of dollar 400 can be realized per passenger, which alternative should be recommended using an interest rate of 15 percentage?Explanation / Answer
Option 1) Purchasing bus for $ 75000 having capacity of 40 passengers.
P.V. of Cash inflow = 400 * 40 * Cumulative Present value factor for 10 years @ 15 % + 8000 * P.V. factor for 10 Th Year @ 15 %
= 400 * 40 * 5.0188 + 8000 * 0.24718
= $ 82278.24
Net Present Value = P.V. of cash inflow - P.V. of cash outflow
= 82278.24 - 75000
= $ 7278.24
Annual Equivalent Value = 7278.24 / 5.0188
= $1450.19 (approx)
Option 2) Purchasing bus for $ 95000 having capacity of 50 passengers.
P.V. of Cash inflow = 400 * 50 * Cumulative Present value factor for 10 years @ 15 % + 12000 * P.V. factor for 10 Th Year @ 15 %
= 400 * 50 * 5.0188 + 12000 * 0.24718
= $ 103342.16
Net Present Value = P.V. of cash inflow - P.V. of cash outflow
= 103342.16 - 95000
= $ 8342.16
Annual Equivalent Value = 8342.16 / 5.0188
= $ 1662.18 (approx)
Conclusion:- Since option 2) Purchasing a bus for $ 95000 having capacity of 50 passengers has higher equivalent annual value, thus, it is the clear winner. The company should purchase a bus for $ 95000 having capacity of 50 passengers instead of going for purchasing a bus for $ 75000 having capacity of 40 passengers.
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