4) Bob\'s Taxi Co. is considering adding 5 taxis to its fleet. It can ether purc

Question

4) Bob's Taxi Co. is considering adding 5 taxis to its fleet. It can ether purchase or lease the taxis. If purchased, each taxi has an initial cost of $18,000; annual O&M; costs of $3,750, and a salvage value of $3,000. Taxis qualify as 3-yr property. if the taxis are leased, beginning-of-year payments of $5,900/taxi, plus operating costs of $1,800/taxi, will be incurred. The taxis will bring in $45,000 in total revenue a year, using a 5-yr planning horizon, a 40% tax rate, a 10% ATMARR, and a PW analysis, should the trucks be purchased or leased? Please show before tax cash flow, depreciation amount, taxable income, and taxes paid, after tax cash flow for each year and PW for each option.

Explanation / Answer

Option 1: TAXIS ARE PURCHASED Annual cash inflows for each year: Revenues 45000 Less: Operating cost@3750 per taxi 18750 Less: Depreciation (18000-3000)/3 *5 25000 Net Income before tax 1250 Less: Tax @40% 500 Net Income after tax 750 Add: Non cash expense-Dep 25000 Annual cash inflows    25750 Total of PV factors @10% for 5 yrs 3.791 Present value of Annual inflows for 5 yrs 97618.25 Add: Present value of Salvage at the end of 5th 9315 (3000*5 *Pv favtor of 5th year i.e. 0.621) Total Present value of inflows 106933.25 Less: Present value of outflows(18000*5) 90,000 Net Present value 16,933 Option 2: Taxis are leased Annual cash inflows for each year: Revenues 45000 Less: Operating cost@1800 per taxi 9000 Less: Lease payment (5900*5) 29500 Net Income before tax 6500 Less: Tax @40% 2600 Net Income after tax 3900 Annual cash inflows    3900 Total of PV factors @10% for 5 yrs 3.791 Present value of Annual inflows for 5 yrs 14784.9 Less: Present value of lease payment made at Year 0 5900 (5900 *1) Add: PV of lease payment not made at the end of Year 5 3663.9 (5900 *0.621) Net Present value of cash inflows 12,549 Hence, Taxis should be purchased as NPV is higher in Option 1

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