Net Present Value Method Annuity E & T Excavation Company is planning an investm

Question

Net Present Value Method Annuity

E & T Excavation Company is planning an investment of $620,100 for a bulldozer. The bulldozer is expected to operate for 3,000 hours per year for seven years. Customers will be charged $140 per hour for bulldozer work. The bulldozer operator costs $30 per hour in wages and benefits. The bulldozer is expected to require annual maintenance costing $30,000. The bulldozer uses fuel that is expected to cost $39 per hour of bulldozer operation.

a. Determine the equal annual net cash flows from operating the bulldozer.

b. Determine the net present value of the investment, assuming that the desired rate of return is 20%. Use the present value of an annuity of $1 table above. Round to the nearest dollar. If required, use the minus sign to indicate a negative net present value.

c. Should E & T invest in the bulldozer, based on this analysis?

d. Determine the number of operating hours such that the present value of cash flows equals the amount to be invested. Round interim calculations and final answer to the nearest whole number.
hours

Present Value of an Annuity of $1 at Compound Interest Year 6% 10% 12% 15% 20% 1 0.943 0.909 0.893 0.870 0.833 2 1.833 1.736 1.690 1.626 1.528 3 2.673 2.487 2.402 2.283 2.106 4 3.465 3.170 3.037 2.855 2.589 5 4.212 3.791 3.605 3.352 2.991 6 4.917 4.355 4.111 3.784 3.326 7 5.582 4.868 4.564 4.160 3.605 8 6.210 5.335 4.968 4.487 3.837 9 6.802 5.759 5.328 4.772 4.031 10 7.360 6.145 5.650 5.019 4.192

Explanation / Answer

a) E & T Excavation company

Calculation of equal annual net cash flow (Amount in $)

b) Calculation of net present value of the investment   

c) As the net present value calculated in part b is $39,615, thus E & T should invest in Bulldozer.

d) For calculating the number of operating hours such that the present value of cash flows equal the amount to be invested we need to create an equation by assuming no. of operating hours equal to X hours.

{[($140-$30-$39)per hour*X] - $30,000}*3.605 = Present value of cash flows (equal to amount to be invested)

[($71 per hour*X)-$30,000]*3.605 = $620,100

(71X - 30,000) = 620,100/3.605

71X = 172,011+30,000

X = 202,011/71 = 2,845 hours (approx.)

Therefore if the company operates at 2,845 hours then the present value of cash flows equals the amount to be invested.

Operating Hours per year 3,000 hours Cash Inflows : Charged from customer ($140 per hour*3,000 hrs) 420,000 Cash Outflows : Bulldozer Operating costs ($30 per hour*3,000 hrs) (90,000) Bulldozer Fuel costs ($39 per hour*3,000 hrs) (117,000) Annual maintenance cost (30,000) Equal annual net Cash flow 183,000

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