19

[QUESTION] [Problem 13.9] The City of San Jose 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 Rockbuilt truck, which costs $74,000, 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 $2,000 a year are expected in the first four years, followed by total maintenance and rebuilding costs of $13,000 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 $9,000. A bid from Bulldog Trucks, Inc., is for $59,000 a truck. Maintenance costs for the truck will be higher. In the first year they are expected to be $3,000, and this amount is expected to increase by $1,500 a year through the eighth year. In the fourth year the engine will need to be rebuilt, and this will cost the company $15,000 in addition to maintenance costs in that year. At the end of eight years the Bulldog truck will have an estimated scrap value of $5,000. a. If the City of San Jose’s opportunity cost of funds is 8 percent, which bid should I accept? Ignore tax considerations, because the city pays no taxes. b. If its opportunity cost were 15 percent, would your answer change? [ANSWER] a. Incremental Time 8% Amount of cash outflow: savings of of cash discount Rockbuilt over Rockbuilt Bulldog outflow factor Bulldog truck 0 1.000 $(74,000) $ (59,000) $(15,000) 1 .926 (2,000) (3,000) 1,000 2 .857 (2,000) (4,500) 2,500 3 .794 (2,000) (6,000) 4,000 4 .735 (2,000) (22,500) 20,500 5 .681 (13,000) (9,000) (4,000)

6 .630 (4,000) (10,500) 6,500 7 .583 (4,000) (12,000) 8,000 8 .540 5,000* (8,500) ** 13,500 Present value of $(91,626) $(111,266) $ 19,637 cash flows at 8% * $4,000 maintenance cost plus salvage value of $9,000. * $13,500 maintenance cost plus salvage value of $5,000. The Rockbuilt bid should be accepted as the lower maintenance and rebuilding expenses more than offset its higher cost. b. Incremental Time 15% Amount of cash outflow: savings of of cash discount Rockbuilt over Rockbuilt Bulldog outflow factor Bulldog truck 0 1.000 $(74,000) $ (59,000) $(15,000) 1 .870 (2,000) (3,000) 1,000 2 .756 (2,000) (4,500) 2,500 3 .658 (2,000) (6,000) 4,000 4 .572 (2,000) (22,500) 20,500 5 .497 (13,000) (9,000) (4,000) 6 .432 (4,000) (10,500) 6,500 7 .376 (4,000) (12,000) 8,000 8 .327 5,000* (8,500) ** 13,500 Present value of $(87,770) $(98,130.5) $ 10,360.5