Bilboa Freightlines, S.A., of Panama, has a small truck that it uses for intraci

Question

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: Present Truck)( New) Truck Purchase cost new $ 23,000 $28,000 Remaining book value $ 10,000 Overhaul needed now $ 9,000 Annual cash operating costs $ 11,500 $ 8,000 Salvage value-now $ 5,000 Salvage value-five years from now $ 4,000 $ 4,000 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 9% discount rate.

Explanation / Answer

Keep Old: Now 1 2 3 4 5 Overhaul -9000 Annual operating costs -11500 -11500 -11500 -11500 -11500 Salvage 4000 Total cash flows -9000 -11500 -11500 -11500 -11500 -7500 Discount @9% 1 0.917431193 0.84167999 0.7721835 0.70843 0.649931 -9000 -10550.45872 -9679.3199 -8880.11 -8146.9 -4874.49 Total Costs -51131.264 Purchase New Now 1 2 3 4 5 Purchase cost -28000 Salvage old(will sold today) 5000 Annual operating costs -8000 -8000 -8000 -8000 -8000 Salvage value 4000 Total cash flows -23000 -8000 -8000 -8000 -8000 -4000 Discount @9% 1 0.917431193 0.84167999 0.7721835 0.70843 0.649931 -23000 -7339.449541 -6733.4399 -6177.468 -5667.4 -2599.73 Total costs -51517.485 Conclusion: Since, present value of total costs in lower in case of keeping old rather than purchasing new and thus, it is better to retain the old machine

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