Net Present Value Method—Annuity Briggs Excavation Company is planning an invest

Question

Net Present Value Method—Annuity

Briggs Excavation Company is planning an investment of $420,800 for a bulldozer. The bulldozer is expected to operate for 2,000 hours per year for five years. Customers will be charged $135 per hour for bulldozer work. The bulldozer operator costs $25 per hour in wages and benefits. The bulldozer is expected to require annual maintenance costing $20,000. The bulldozer uses fuel that is expected to cost $33 per hour of bulldozer operation.

a. Determine the equal annual net cash flows from operating the bulldozer. Use a minus sign to indicate cash outflows.

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a. Subtract the operating expenses (hourly fuel and labor costs, multiplied by the operating hours, plus the annual maintenance costs) from the revenues (operating hours multiplied by the hourly revenue).

Learning Objective 3.

b. Determine the net present value of the investment, assuming that the desired rate of return is 20%. Use the present value of an annuity of $1 table above. Round to the nearest dollar. If required, use the minus sign to indicate a negative net present value.

c. Should Briggs Excavation invest in the bulldozer, based on this analysis?
No , because the bulldozer cost is more than the present value of the cash flows at the minimum desired rate of return of 20%.

d. Determine the number of operating hours such that the present value of cash flows equals the amount to be invested. Round interim calculations and final answer to the nearest whole number.
hours

Present Value of an Annuity of $1 at Compound Interest Year 6% 10% 12% 15% 20% 1 0.943 0.909 0.893 0.870 0.833 2 1.833 1.736 1.690 1.626 1.528 3 2.673 2.487 2.402 2.283 2.106 4 3.465 3.170 3.037 2.855 2.589 5 4.212 3.791 3.605 3.353 2.991 6 4.917 4.355 4.111 3.785 3.326 7 5.582 4.868 4.564 4.160 3.605 8 6.210 5.335 4.968 4.487 3.837 9 6.802 5.759 5.328 4.772 4.031 10 7.360 6.145 5.650 5.019 4.192

Explanation / Answer

a.

b.

c. No, because the bulldozer cost is more than the present value of the cash flows at the minimum desired rate of return of 20%.

d.  For the present value of cash flows to equal the amount to be invested, the annual net cash flows must be $420800/2.991 = $140688.73 = $140689

Assuming the number of operating hours to be "X"

$140689 = 135X - (58X + 20000)

140689 = 135X - 58X - 20000

77X = $160689

X = $160689/77 = 2086.87 = 2087 hours

The number of operating hours = 2087 hours

Check for 2087 operating hours:

Briggs Excavation Company Equal Annual Net Cash Flows Cash inflows: Hours of operation 2000 Revenue per hour $        135 Revenue per year $       270,000 Cash outflows: Hours of operation 2000 Fuel cost per hour $          33 Labor cost per hour $          25 Total fuel and labor costs per hour $          58 Fuel and labor costs per year $ -116,000 Maintenance costs per year $ -20,000 Annual net cash flows $ 134,000

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