The city I work for needs a number of new special purpose trucks.  It
has recieved several bids and has closley evaluated the performance
characteristics of the various trucks.  Each AAA truck costs $74,000,
but it is top of the line equipment.  The truck has a life of 8 years,
assuming that the engine is rebuilt in the fifth year.  Maintenance
costs of $2,000 a year are expcted in the first four years, followed
by total maintenance rebuilding costs of $13,000 in the fifth year. 
During the last 3 years, maintenance costs are expected to be $4,000 a
year.  At the end of 8 years, the truck will have an estimated scrap
value of $9,000.
 A bid from BBB truck is for $59,000 a truck; however, maintenance
costs for this 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 year 4, 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 8 years, the BBB
truck will have an estimated scrap value of $5,000.
 The last bidder, CCC, has agreed to sell the city trucks for $44,000
each.  Maintenance costs in the first 4 years are expected to be
$4,000 the first year and to increase by $1,000 a year.  For the
cities purposes, the truck has a life of only 4 years.  At that time
it can be traded in for a new CCC truck, which is expected to cost
$52,000.  The likely trade-in-value of the old truck is $15,000. 
During years 5 thru 8, the second truck is expected to increase by
$1,000 each year.  At the end of 8 years, the second truck is expected
to have a resale or salvage value of $18,000.


  If the cities cost of funds is 8 percent, which bid should it
accept?  Ignore any tax consideration, as the city pays no taxes.

  If its opportunity cost were 15 percent, would the answer change?

PLEASE, IF POSSIBLE, PROVIDE AN ANSWER WITHIN THE NEXT 24 HOURS. THANK YOU

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Request for Question Clarification by livioflores-ga on 07 Oct 2003 05:18 PDT

Can you clarify the mantenaince costs of the second truck in the ccc
case, what is the cost of the fifth year? Is the cost of the fourth
year plus $1000 or you forgot to write this initial amount?
Thank you.

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Clarification of Question by jimmy5-ga on 07 Oct 2003 06:04 PDT

During years 5 thru 8, the second truck is expected to have
maintenance costs of $5,000 in year 5, and these are expected to
increase by $1,000 each year.

Sorry

Hi jimmy5!!


For each truck the initial investment is $xxx, to this investment we
must add all the expenses for the next 8 years considering the
appropiate Discount Factors. The sum of all of this values gives us
the Present Value of the total expensditures that the city did for
this truck, this value less the Present Value of the scrap value will
show the Net Present Value of all these expenditures. After do the
same with the three bids we must choose the one with fewer NPV,
because this means that the total amount of money spent in this truck
converted to the actual value of money is fewer for this truck.

Discounted Cash Flow Analysis:
A dollar today is worth more than a dollar tomorrow – by exactly the
rate of
interest between today and tomorrow (Present Value).
We can apply this rule to a sequence of cash flows in the future to
convert them to an equivalent single cash payment today (net present
value (NPV)).

For Discount factors reference and table see the following page:
"Discounted present value ":
http://www.fao.org/docrep/X5648E/x5648e0k.htm


AAA Truck:
I = $74000
Y1 = $2000 * 0.926 = $1852
Y2 = $2000 * 0.857 = $1714
Y3 = $2000 * 0.794 = $1588
Y4 = $2000 * 0.735 = $1470
Y5 = $13000 * 0.681 = $8853
Y6 = $4000 * 0.630 = $2520
Y7 = $4000 * 0.583 = $2332
Y8 = $4000 * 0.540 = $2160
sv = -$9000 * 0.540 = -$4860
NPV = $91629


BBB Truck:
I = $59000
Y1 = $3000 * 0.926 = $2778
Y2 = $(3000 + 1500) * 0.857 = $3856.5
Y3 = $(4500 + 1500)* 0.794 = $4764
Y4 = $(6000 + 1500 + 15000) * 0.735 = $16537.5
Y5 = $(7500 + 1500) * 0.681 = $6129
Y6 = $(9000 + 1500) * 0.630 = $6615
Y7 = $(10500 + 1500) * 0.583 = $6996
Y8 = $(12000 + 1500)* 0.540 = $7290
sv = -$5000 * 0.540 = -$2700
NPV = $111266


CCC Truck:
I = $44000
Y1 = $4000 * 0.926 = $3704
Y2 = $(4000 + 1000) * 0.857 = $4285
Y3 = $(5000 + 1000)* 0.794 = $4764
Y4 = $(6000 + 1000) * 0.735 = $5145
New Truck = $(52000 - 15000) * 0.735 = $27195
Y5 = $5000 * 0.681 = $3405
Y6 = $(5000 + 1000) * 0.630 = $3780
Y7 = $(6000 + 1000) * 0.583 = $4081
Y8 = $(7000 + 1000)* 0.540 = $4320
sv = -$18000 * 0.540 = -$9720
NPV = $94959

The city must accept the bid of AAA Trucks.

If the city cost of funds were 15 percent we must to re-evaluate the
cases using the 15% Discount Factors.
 
AAA Truck:
I = $74000
Y1 = $2000 * 0.870 = $1740
Y2 = $2000 * 0.756 = $1512
Y3 = $2000 * 0.658 = $1316
Y4 = $2000 * 0.572 = $1144
Y5 = $13000 * 0.497 = $6461
Y6 = $4000 * 0.432 = $1728
Y7 = $4000 * 0.376 = $1504
Y8 = $4000 * 0.327 = $1308
sv = -$9000 * 0.327 = -$2943
NPV = $87770


BBB Truck:
I = $59000
Y1 = $3000 * 0.870 = $2610
Y2 = $(3000 + 1500) * 0.756 = $3402
Y3 = $(4500 + 1500)* 0.658 = $3948
Y4 = $(6000 + 1500 + 15000) * 0.572 = $12870
Y5 = $(7500 + 1500) * 0.497 = $4473
Y6 = $(9000 + 1500) * 0.432 = $4536
Y7 = $(10500 + 1500) * 0.376 = $4512
Y8 = $(12000 + 1500)* 0.327 = $4414.5
sv = -$5000 * 0.327 = -$1635
NPV = $98130.5


CCC Truck:
I = $44000
Y1 = $4000 * 0.870 = $3480
Y2 = $(4000 + 1000) * 0.756 = $3780
Y3 = $(5000 + 1000)* 0.658 = $3948
Y4 = $(6000 + 1000) * 0.572 = $4004
New Truck = $(52000 - 15000) * 0.572 = $21164
Y5 = $5000 * 0.467 = $2335
Y6 = $(5000 + 1000) * 0.432 = $2592
Y7 = $(6000 + 1000) * 0.376 = $2632
Y8 = $(7000 + 1000)* 0.327 = $2616
sv = -$18000 * 0.327 = -$5886
NPV = $84665

In this case the better bid is the CCC Trucks.


I hope this helps you, if you find something unclear or may be some
mistake with calculations please ask for a request for an answer
clarification before rate this answer.

Best regards.
livioflores-ga

Good work