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%.
a) calculate the net present value, ignoring the additional benefits described by rick

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

The NPV of the project ignoring benefits are as follows:

NPV is -13,917.98 (negative)

Year 0 1 2 3 4 5 6 7 8 Initial cost -60050 Annual Cash flow 8010 8010 8010 8010 8010 8010 8010 8010 Overhaul costs -5970 Salvage Value 12010 Net Cash flow -60050 8010 8010 8010 2040 8010 8010 8010 20020 NPV at 9% $   -13,917.98

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