Problem 13-28 Net Present Value Analysis [LO13-2] Bilboa Freightlines, S.A., of
ID: 2437393 • Letter: P
Question
Problem 13-28 Net Present Value Analysis [LO13-2]
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 6% 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 $ 34,000 $ 44,000 Remaining book value $ 21,000 - Overhaul needed now $ 20,000 - Annual cash operating costs $ 16,500 $ 15,000 Salvage value-now $ 10,000 - Salvage value-five years from now $ 9,000 $ 9,000
Explanation / Answer
Alternative-1 Keep the old truck Annual Cash operating cost -16500 Annuity Present value factor for 5 yrs at 6% 4.2124 Present value of operating cost -69505 Add: Present value of overhauling -20000 Total present value of outflows -89505 Less: Present value of salvage 6726 (9000*0.7473) Net present value -82779 Alternative-2 Purchase of New truck Annual Cash operating cost -15000 Annuity Present value factor for 5 yrs at 6% 4.2124 Present value of operating cost -63186 Add: Net initial Investment -34000 (44000-10000) Total present value of outflows -97186 Less: Present value of salvage 6726 (9000*0.7473) Net present value -90460 hence, The company must KEEP the old truck