Jane’s Auto Care is considering the purchase of a new tow truck. The garage does

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 $60,050 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.

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.

The company’s cost of capital is 9%. Suppose Rick has been overly optimistic in his assessment of the value of the additional benefits. At a minimum, how much would the additional benefits have to be worth in order for the project to be accepted? (Round answer to 0 decimal places, e.g. 125.)

Initial cost $60,050 Estimated useful life 8 years Net annual cash flows from towing $8,010 Overhaul costs (end of year 4) $5,970 Salvage value $12,010

Explanation / Answer

Calculation of NPV of Truck Particulars Year Amount 9% Factor Present value C D C X D Cash Inflow Net Cash Inflow 1-8            8,010            5.5348                  44,334 A. Total Cash Inflow - PV                  44,334 Cash Outflow Cost of Truck 0         60,050            1.0000                  60,050 Ovehauling Cost 4            5,970            0.7084                     4,229 B. Total Cash Outflow - PV                  64,279 NPV (A - B)                (19,945) The Minimum returns from the additional benefits should be PV of $19945 worth . or the Annual Net Inflow from Additional benefits = $19945 / 5.5348 = $3603.63 or $3604 (Approx)

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