Buy Cost And Benefits Are Incurred

Buy Cost And Benefits Are Incurred
17.2. A city has learned that by buying larger garbage trucks, it could reduce labor costs for garbage removal.
· Cost of the trucks today is $400,000.
· Annual savings in this year’s constant dollars is $90,000.
· Trucks will last for 4 years and then will be sold for $100,000.
· The city can borrow money at a 7% discount rate to purchase the trucks.
· Inflation (for the next 4 years) is expected to average 3%.
Note: All the dollar amounts are in this year’s dollars (constant dollars).
Assuming the costs and benefits are incurred at the end of the year, should the city buy the trucks?
17.3. This problem extends the garbage truck problem from assignment 2. Two other lenders provide alternative scenarios. Alternate lender 1 suggests that the inflation rate will be 4% and offers an interest rate of 7.5%, while alternate lender 2 suggests that the inflation rate will be 1% and offers an interest rate of 6.5%. For all three sources, the interest rates are guaranteed if the decision is made in the next 90 days. Which of the following decisions should be made and why?
(a) The usual lender should be used because she offers a positive NPV.
(b) Alternate lender 1 should be used because he offers the highest NPV.
(c) The garbage trucks shouldn’t be purchased because there is a possibility of a negative NPV.
(d) Alternate lender 2 should be used because most scenarios have a positive NPV and she offers the highest NPV under each scenario.
(e) Each solution is as good as any other.
x
Buy Cost And Benefits Are Incurred
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Exercise 17.2
City Garbage Truck Purchase Decision To show the cell checking, put a check here: x Percent Correct this page 0%
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Question:
A city has learned that by buying larger garbage trucks, labor costs for garbage removal would be reduced.
Cost of the trucks today: 400,000
Annual savings in this year’s constant dollars 90,000
Trucks will last for 4 years, then be sold for: 100,000
The city can borrow money (discount rate) at: 7.00%
Inflation (next 4 years) is expected to average: 3.00%
Note: all the dollar amounts are in this year’s dollar (constant dollar).
Assuming the cost and benefit incur at the end of the year, should the city buy the trucks?
Answer:
Calculation:
Buy Cost And Benefits Are Incurred
Real Dollars Nominal Doll. Present value
Description Time Costs/Benefits Costs/Benefit
Purchase 0 -400,000
Benefits 1 90,000
Benefits 2 90,000
Benefits 3 90,000
Benefits 4 90,000
Residual 4 100,000
Total Net PV
Select one (with “x”):
The city should not buy the trucks because the net present value of the decision is positive.
The city should buy the trucks because the net present value of the decision is

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