ABC Construction must replace a number of its concrete mixer trucks with new tru

Question

ABC Construction must replace a number of its concrete mixer trucks with new trucks. It has received two bids and has evaluated closely the performance characteristics of the various trucks. The truck A, which cost $78,000, is top of the line equipment. The truck has a life of 8 years, assuming the engine is rebulit on the fifth year.

Maintenance cost of $2,500 a year expected in the first four years, followed by total maintenance and rebuilding cost of $12,000 in the fifth year. During the last three years, maintenance cost are expected to be $4,000 a year. At the end of the 8 years the truck will have an estimated scrap value of $10,000.

The trucks B cost $46,000 a truck. Maintenance cost for the truck will be higher. In the first year they are expercted to be $4000 and this amount is expected to increase by $1,500 a year through the 8 year. In the fourth year the engine will need to be rebuilt, and this will cost the company $18,000 in addition to maintenance cost in that year. At the end of eight years the trucks will have an estimated scrap value of $7,000

1) using MACRS(5 years property) estimate the after-tax cash flows related to the trucks?(Use tax rate of 35%)

2) if ABC construction's opportunity cost of funds is 10%, which truck should it accept?

3) If its opportunity cost were 15% would you answer change?

(15) 2. ABC Construction must replace a number of its concrete mixer trucks with new trucks. It has received two bids and has evaluated closely the performance characteristics of the various trucks. The truck A, which costs $78,000, is top-of-the-line equipment. The truck has a life of eight years, assuming that the engine is rebuilt in the fifth year. Maintenance costs of $2,500 a year are expected in the first four years, followed by total maintenance and rebuilding costs of $12,000 in the fifth year. During the last three years, maintenance costs are expected to be $4,000 a year At the end of eight years the truck will have an estimated scrap value of $10,000.

Explanation / Answer

1)

2) If the cost of funds is 10%, the NPV of the two investments would be calculated:

Based on the above NPV, Truck B should be accepted as it has a lower negative NPV.

3) If the opportunitty cost were 15%, the NPV at this cost of capital are:

Yes, the answer would chnage and now truck A would be accepted as it has a lower negative NPV value.

Truck A 0 1 2 3 4 5 6 7 8 Maintenance cost -$2,500 -$2,500 -$2,500 -$2,500 -$12,000 -$4,000 -$4,000 -$4,000 Depreciation -$15,600 -$24,960 -$14,976 -$8,986 -$8,986 -$4,493 Total operating cost -$18,100 -$27,460 -$17,476 -$11,486 -$20,986 -$8,493 -$4,000 -$4,000 Tax -$6,335 -$9,611 -$6,117 -$4,020 -$7,345 -$2,972 -$1,400 -$1,400 After tax income -$11,765 -$17,849 -$11,359 -$7,466 -$13,641 -$5,520 -$2,600 -$2,600 Operating cash flows $3,835 $7,111 $3,617 $1,520 -$4,655 -$1,028 -$2,600 -$2,600 Initial investment -$78,000 Terminal value $6,500 Net cash flows -$78,000 $3,835 $7,111 $3,617 $1,520 -$4,655 -$1,028 -$2,600 $3,900

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