A recent graduate who wants to start an excavation/earth-moving business is tryi

ID: 2589910 • Letter: A

Question

A recent graduate who wants to start an excavation/earth-moving business is trying to determine which size of used dump truck to buy. He knows that as the bed size increases, the net income increases, but he is uncertain whether the incremental expenditure required for the larger trucks is justified. The cash flows associated with each size of the truck are estimated below. The contractor has established an MARR bf 18% per year, and all trucks are expected to have a remaining economic life of 5 years. Which size truck should he purchase? (Hint: Use Excel) 2. Truck Bed Size, Initial m3 M&o; $/Year Salvage Value Annual 10 15 20 25 Investment, $ -30,000 34,000 38,000 -48,000 -57,000 14,000 15,500 18,000 -21,000 -26,000 +2,000 +2,500 +3,000 +3,500 +4,600 Revenue, $/Year +26,500 +30,000 +33,500 +40,500 +49,000

Explanation / Answer

Cost of capital = 18%

Useful life = 5 Years

Net cash inflow = Annual revenue –M&O cost per year

Initial Investment

30,000

34,000

38,000

48,000

57,000

Net cash inflow

12,500

14,500

15,500

19,500

23,000

Salvage value

2000

2500

3000

3500

4600

PVF@18% of

5th year

0.437

PVAF @18% for 5 Years

3.127

Present Value of Cash Inflow

39,087.5

(12,500*3.127)

45,341.5

(14,500*3.127)

48,468.5

(15,500* 3.127)

60,976.5

(19,500*3.127)

71,921

(23,000*3.127)

Present value of Salvage

874

(2000*0.437)

1092.5

(2500*0.437)

1311

(3000*0.437)

1529.5

(3500*0.437)

2010.2

(4600*0.437)

NPV = Present value of cash inflows – initial cash outflow + Present value of salvage

8 = 39,087.5 - 30,000 + 874 = 9961.5

10 = 45,341.5 – 34,000 + 1092.5 = 12,434

15 = 48,468.5 – 38,000 + 1311 = 11,779.5

20 = 60,976.5 – 48,000 + 1529.5 = 14,506

25 = 71,921 – 57,000 + 2010.2 = 16,931.2

He should select Truck 25 as NPV is highest in that case.