You are put in charge of replacing the fleet of sales and executive automobiles

Question

You are put in charge of replacing the fleet of sales and executive automobiles for your company. Three types of cars have been identified. The first type would cost less upfront, have higher maintenance cost, and lower salvage values after shorter lives. The second type would cost a little more upfront, have slightly lower maintenance cost, and slightly higher salvage values after slightly longer operating lives. The third type would cost more upfront, have lower maintenance cost, and higher salvage values after longer operating lives. The cash flow estimates for each type is given below: Type one: Purchase price per car $26,000; Annual operating expense per car $6,000; Disposition value per car $10,000; Estimated useful life of the car 4 years Type two: Purchase price per car $42,000; Annual operating expense per car $5,600; Disposition value per car $15,500; Estimated useful life of the car 6 years Type three: Purchase price $58,000; Annual operating expense $4,800; Disposition value $18,000; Estimated useful life of the asset 8 years All cars can be replaced at the end of their asset lives. Using a 7.0 percent discount rate and the equivalent annuity method, which car is the better investment? Please show the NPV, and Equivalent annuity for each type of car. NPV Equivalent Annuity Car Type One ____________________ _____________ Car Type Two ____________________ _____________ Car Type Three ____________________ _____________

Explanation / Answer

NPV = -Purchase price – Annual operating expense* (P/A,7%,n)+ Disposition value*(P/F,7%,n)

Type 1= -26000- 6000*(P/A,7%,4)+ 10000*(P/F,7%,4)

=-26000- 6000*3.387 + 10000*0.7629

=-38693

EUAC = NPV*(A/P,7%,4)

=38693*0 .2952

=11422.17

Type 2= -42000- 5600*(P/A,7%,6)+ 15500*(P/F,7%,6)

=-42000- 5600* 4.767 + 15500*0 .6227

=-59043.35

EUAC = NPV*(A/P,7%,6)

=59043.35*0 .1856

=10958.446

Type 3= -58000- 4200*(P/A,7%,8)+ 18000*(P/F,7%,8)

=-58000- 4200* 5.971 + 18000*0 .5820

=-72602.2

EUAC = NPV*(A/P,7%,8)

=72602.2*0.1675

=12160.87

Since Type 2 is the lowest EUAC, that is the best investment.

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