Problem 12-4A (Part Level Submission) (a) LINK TO TEXT LINK TO TEXT (b) Problem
ID: 2491374 • Letter: P
Question
Problem 12-4A (Part Level Submission)
(a)
LINK TO TEXT
LINK TO TEXT
(b)
Problem 12-4A (Part Level Submission)
Jane’s Auto Care is considering the purchase of a new tow truck. The garage doesn’t currently have a tow truck, and the $59,950 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 $59,950 Estimated useful life 8 years Net annual cash flows from towing $7,990 Overhaul costs (end of year 4) $5,970 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 740 Additional annual net cash flows from customer “goodwill” 980 Additional annual net cash flows resulting from free advertising 750
The company’s cost of capital is 9%.
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(a)
Your answer is partially correct. Try again. Calculate the net present value, ignoring the additional benefits described by Rick. (If the net present value is negative, use either a negative sign preceding the number eg -45 or parentheses eg (45). Round answer to 0 decimal places, e.g. 125. For calculation purposes, use 5 decimal places as displayed in the factor table provided.)Net present value $
Should the tow truck be purchased?
The tow truck
shouldshould not
be purchased.LINK TO TEXT
LINK TO TEXT
Attempts: 5 of 5 used(b)
Calculate the net present value, incorporating the additional benefits suggested by Rick. (If the net present value is negative, use either a negative sign preceding the number eg -45 or parentheses eg (45). Round answer to 0 decimal places, e.g. 125. For calculation purposes, use 5 decimal places as displayed in the factor table provided.)Net present value $
Should the tow truck be purchased?
The tow truck
shouldshould not
be purchased.Explanation / Answer
(a)
Cost of capital 9% Cumulative discount facator = {1-(1+i)^-n}/i Present value of cash inflow (A) = {1-(1+.09)^-8}/.09 Annual Cash inflow*cumulative discount factor = 5.535 = 7990*5.535 = 44225 Present value of salvage amount Discount facator = Salvage amount*Discount factor = (1+i)^-n = 12000*.502 = (1.09)^-8 = 6024 = 0.502 Total presentvalue of cash inflow = 50249 Present value of cash outlow (B) Present value of initial cost = Initial cost*discount factor = 59950*1 = 59950 Present value of overhaul cost Discount facator = Overhaul cost*discount factor = (1+i)^-n = 5970*.708 = (1.09)^-4 = 4227 = 0.708 Total present value of cash outflow = 64177 Net Present value (A)-(B) = -13928 No, due to negative net present value , truck should not be purchased.