Problem 13-28 Net Present Value Analysis [LO13-2] Bilboa Freightlines, S.A., of
ID: 2658067 • 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
Answer 1 Calculation of the net present value of the “keep the old truck” alternative Year 0 1 2 3 4 5 NPV Overhaul cost -$20,000.00 Operating cost -$16,500.00 -$16,500.00 -$16,500.00 -$16,500.00 -$16,500.00 Salvage value $9,000.00 Net Cash flow -$20,000.00 -$16,500.00 -$16,500.00 -$16,500.00 -$16,500.00 -$7,500.00 x Discount factor @ 6% 1 0.943396226 0.88999644 0.83961928 0.79209366 0.74725817 Present Values -$20,000.00 -$15,566.04 -$14,684.94 -$13,853.72 -$13,069.55 -$5,604.44 -$82,778.68 The net present value of the “keep the old truck” alternative -$82,778.68 Answer 2 Calculation of the net present value of the “purchase the new truck” alternative Year 0 1 2 3 4 5 NPV Purchase Cost -$44,000.00 Salvage value of old truck $10,000.00 Operating cost -$15,000.00 -$15,000.00 -$15,000.00 -$15,000.00 -$15,000.00 Salvage value $9,000.00 Net Cash flow -$34,000.00 -$15,000.00 -$15,000.00 -$15,000.00 -$15,000.00 -$6,000.00 x Discount factor @ 6% 1 0.943396226 0.88999644 0.83961928 0.79209366 0.74725817 Present Values -$34,000.00 -$14,150.94 -$13,349.95 -$12,594.29 -$11,881.40 -$4,483.55 -$90,460.13 The net present value of the “purchase the new truck” alternative -$90,460.13 Answer 3 Bilboa Freightlines sould keep the old truck as NPV is higher in this alternative compared to purchase option.