Problem 26-4A Jane’s Auto Care is considering the purchase of a new tow truck. T

Question

Problem 26-4A

Jane’s Auto Care is considering the purchase of a new tow truck. The garage doesn’t currently have a tow truck, and the $60,030 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%.

Initial cost $60,030 Estimated useful life 8 years Net annual cash flows from towing $8,040 Overhaul costs (end of year 4) $5,960 Salvage value $12,000

Explanation / Answer

Jane's Auto care Year Initial cost & Overhaul costs Net annual cash flows from towing Annual cash flow from repair work Annual savings from plowing Annual cash flow from goodwill Annual cash flow resulting from advertising Salvage value Net Cash Inflows PVIF@9% Present Value 0 60030 -60030 1 -60030 1 8040 3000 750 990 740 13520 0.9174 12404 2 8040 3000 750 990 740 13520 0.8417 11380 3 8040 3000 750 990 740 13520 0.7722 10440 4 5960 8040 3000 750 990 740 7560 0.7084 5356 5 8040 3000 750 990 740 13520 0.6499 8787 6 8040 3000 750 990 740 13520 0.5963 8062 7 8040 3000 750 990 740 13520 0.5470 7396 8 8040 3000 750 990 740 12000 25520 0.5019 12808 Total Net present Value 16601 Since Net present value is positive i.e. 16601 the new tow truck should be purchased. Also since project has internal rate of return of 16% which is far more than cost of capital Its worthy of Investment to buy a new tow truck. excell fromula of irr is as follows =IRR(I5:I13,10) Thank You

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