Jane’s Auto Care is considering the purchase of a new tow truck. The garage does
ID: 2475018 • Letter: J
Question
Jane’s Auto Care is considering the purchase of a new tow truck. The garage doesn’t currently have a tow truck, and the $60,000 price tag for a new truck would represent a major expenditure. Jane Austen, owner of the garage, has compiled the estimates shown below in trying to determine whether the tow truck should be purchased. Initial cost $60,000 Estimated useful life 8 years Net annual cash flows from towing $8,006 Overhaul costs (end of year 4) $5,992 Salvage value $11,990 Jane’s good friend, Rick Ryan, stopped by. He is trying to convince Jane that the tow truck will have other benefits that Jane hasn’t even considered. First, he says, cars that need towing need to be fixed. Thus, when Jane tows them to her facility, her repair revenues will increase. Second, he notes that the tow truck could have a plow mounted on it, thus saving Jane the cost of plowing her parking lot. (Rick will give her a used plow blade for free if Jane will plow Rick's driveway.) Third, he notes that the truck will generate goodwill; people who are rescued by Jane’s tow truck will feel grateful and might be more inclined to use her service station in the future or buy gas there. Fourth, the tow truck will have “Jane’s Auto Care” on its doors, hood, and back tailgate—a form of free advertising wherever the tow truck goes. Rick estimates that, at a minimum, these benefits would be worth the following. Additional annual net cash flows from repair work $2,993 Annual savings from plowing 743 Additional annual net cash flows from customer “goodwill” 985 Additional annual net cash flows resulting from free advertising 754 The company’s cost of capital is 9%.
Explanation / Answer
We have calculate the net present value of the purchase of tow truck. Which means calculate present value of annual cash flows and present value of all cash outflows .If it is positive then to tow truck will be purchased . The following assumptions will be taken
The initial investment of tow truck is $60,000
The life span is 8 years
The salvage value at end of 8 years is 11,990
The overhaul cost at end of year 4 is $5,992
The cash inflows on annual basis for next 8 years are
Net annual cashflow from towing is $ 8,006
annual net cash flows from repair work $2,993
Annual savings from plowing $743
Additional annual net cash flows from customer “goodwill” $985
annual net cash flows resulting from free advertising $754
the total annual cash flow is $13,481
the cost of capital is 9%
the present value of $1 received annually for 8 years at 9% is 5.5348
the present value of $1 received at end of 8 years at 9% is 0.5019
the present value of $1 paid at end of 4 years at 9% is 0.7084
now we calculate the NPV
Particulars
Amount($)
Present value of cash inflow for 8 years = $13481 X 5.5348
74,615
Present value of salvage at the end of 8 years = $11990 X 0.5019
6,018
Present value of total cash inflows
80,632
Less-:
present value of cash oulflow on purchase of tow truck
60,000
present value of overhaul cost at end of 4 years= $5992 x 0.7084
4,245
present value of total cash outflows
64,245
Net present value (total cash inflows minus total Cash outflows)
16,388
As the net present value is positive the garage should purchase tow truck
Particulars
Amount($)
Present value of cash inflow for 8 years = $13481 X 5.5348
74,615
Present value of salvage at the end of 8 years = $11990 X 0.5019
6,018
Present value of total cash inflows
80,632
Less-:
present value of cash oulflow on purchase of tow truck
60,000
present value of overhaul cost at end of 4 years= $5992 x 0.7084
4,245
present value of total cash outflows
64,245
Net present value (total cash inflows minus total Cash outflows)
16,388
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