A sales engineer has the following alternatives to consider in touring his sales

Question

A sales engineer has the following alternatives to consider in touring his sales territory. a) Buy a new car for $14,500. Salvage value is expected to be about $5,000 after 3 years. Maintenance and insurance cost is $1000 in the first year and increases at the rate of $500/year in subsequent years. Daily operating expenses are $50/day b) Rent a similar car for $80/day Based on a 12% after-tax rate of return, how many days per year must he use the car to justify its purchase? You may assume that this sales engineer is in the 30% corporate incremental tax bracket. Use MACRS depreciation.

Explanation / Answer

The Minimum, No of days the Engineer must use the car in order to justify its purchase = 150 days.

The calculations are given below:

The MARCS calculation of depreciation is shown below:

Cash Flows (Buying) Cash Tax Shield outflow on Net Year Vehicle Maintenance Salvage Total after tax Marcs Cash PVIF- 12% Cost & Insurance Value Cash flow Shield Depn Flow at 30% PV 0 -14500 -14500 -10150 0 -10150 1.000 -10150 1 -1000 -1000 -700 2850 2150 0.893 1920 2 -1500 -1500 -1050 0 -1050 0.797 -837 3 -2000 5000 3000 2100 0 2100 0.712 1495 -7573 Note: It is assumed that all expenditures are incurred at the year end. The PV of total Cash Out Flows = -7573 $ The Equivalent Annual Cost would be = 7573/2.402 = 3155 $ for buying a car, without considering daily maintenance charges After tax savings in Daily Expenses if car is bought instead of hiring = 0.70 * (80-50) = 21 $ ` Therefore, minimum no of days the car must be used under the buying alternative = 150 days. to justify its purchase.

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