EmKay Carriers is considering the purchase of a new truck to replace one of its

Question

EmKay Carriers is considering the purchase of a new truck to replace one of its aging trucks. The current truck has a remaining life of 5 years and it is expected to have a salvage value of $25,000 at the end of its useful life. Operating and maintenance costs have been $40,000/yr. Currently the truck has a market value of $75,000. A new truck will have an initial cost of $250,000 and an estimated life 15 years. Its market value at the end of 5 years is expected to be $150,000 and it has an annual operating and maintenance cost of $20,000. If this new truck is purchased, then the company expects to sell the existing truck at its market value.

Based on a present worth analysis over a 5-year planning horizon, determine if the existing truck should be replaced or not, given MARR is 10% per year compounded annually.   DO NOT USE EXCEL

Explanation / Answer

Option 1 Present value of cost to be incurred for exiting truck over a 5 year period = PV of operating & maintenance cost - PV of salvage value at the end of 5th year Cumulative PV factor at 10% for 5 year = 3.790787 PV Factor at 10% for 5 th year = 0.620921 Present value of cost to be incurred for exiting truck over a 5 year period = ($40000 * 3.790787) - ($25000*0.620921) = $136108.50 Option 2 Present value of cost to be incurred for New truck over a 5 year period = Cost of new truck - Market value of exiting truck + PV of operating & maintenance cost - PV of salvage value at the end of 5th year Present value of cost to be incurred for New truck over a 5 year period = $250000 - $75000 + ($20000*3.790787) - ($150000*0.620921) = $157677.60 As the present value of cost to be incurred in case exting truck is on low compared to new truck , hence the exiting truck should not be replaced.

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