Use the following to answer question 41 Table 14.14 Year Costs with Old Taxicabs

Question

Use the following to answer question 41 Table 14.14 Year Costs with Old Taxicabs $20,000 20,000 20,000 (20,000 + 150,000) 5,000 Net Difference Costs with New Taxicabs -$150,000 0 5,000 5,000 5,000 5,000 4 41. (Table 14.14) Metro Cab is considering replacement of its fleet of old taxicabs. To replace its fleet, Metro must spend $150,000 on new taxicabs. The new taxis will incur $5,000 ofmaintenance expenses per year. Alternatively, Metro could spend $20,000 today to refurbish its taxicabs and incur an additional $20,000 per year of maintenance expenses for the next three years. Metro would then have to buy new taxicabs for $150,000 at the end of three years, leading to lower maintenance expenses of $5,000 per year a. Complete the last column of the table At an interest rate of 10%, should Metro purchase the new taxicabs today or postpone the purchase until the end of the third year?

Explanation / Answer

a) The difference between new and old cost structure is given below

b) Note that the NPV of this increment is 0 at optimum IRR

Find the IRR so that -130000 + 15000(P/A, i%, 3) + 150000(P/F, i%, 3) = 0

Trial and error gives i% to be in range of 12% and 18%.

Find the IRR using interpolation

12% + (18% - 12%)(NPV(12%)/(NPV(12%) - NPV(18%))

= 12% + (18% - 12%)(12794.51/(12794.51 + 6091.28))

= 16.0648%

Since IRR > 10%, we should go with new taxicabs

Year Net difference 0 -130000 1 15000 2 15000 3 165000 4 0

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