(a) LINK TO TEXT Jane’s Auto Care is considering the purchase of a new tow truck
ID: 2477827 • Letter: #
Question
(a)
LINK TO TEXT
Jane’s Auto Care is considering the purchase of a new tow truck. The garage doesn’t currently have a tow truck, and the $59,990 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 $59,990 Estimated useful life 8 years Net annual cash flows from towing $7,998 Overhaul costs (end of year 4) $6,008 Salvage value $12,010
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 $2,991 Annual savings from plowing 745 Additional annual net cash flows from customer “goodwill” 963 Additional annual net cash flows resulting from free advertising 742
The company’s cost of capital is 9%.
Click here to view the factor table.
(For calculation purposes, use 5 decimal places as displayed in the factor table provided.)
Explanation / Answer
1
Calculation of the net present value, ignoring the additional benefits described by Rick:
Year
Cash Flows
PVF (9%)
PV = CF*PVF
Initial cost
0
$ (59,990.00)
1.00000
$ (59,990.00)
Net annual cash flows from towing
1 to 8
$ 7,998.00
5.53482
$ 44,267.49
Overhaul costs (end of year 4)
$ (6,008.00)
0.70843
$ (4,256.25)
Salvage value
8
$ 12,010.00
0.50187
$ 6,027.46
Net Present Value
$ (13,951.30)
2
The tow truck should not be purchased.
Because the NPV of the proposal is Negative.
1
Calculation of the net present value, ignoring the additional benefits described by Rick:
Year
Cash Flows
PVF (9%)
PV = CF*PVF
Initial cost
0
$ (59,990.00)
1.00000
$ (59,990.00)
Net annual cash flows from towing
1 to 8
$ 7,998.00
5.53482
$ 44,267.49
Overhaul costs (end of year 4)
$ (6,008.00)
0.70843
$ (4,256.25)
Salvage value
8
$ 12,010.00
0.50187
$ 6,027.46
Net Present Value
$ (13,951.30)
2
The tow truck should not be purchased.
Because the NPV of the proposal is Negative.
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