Assuming the cost and benefits are incurred at the end of the year, should the city buy the trucks?

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Questions

Scenario 1
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
Type your name here, Last Name First
Type your name here, Last Name First

Exercise 17.2

City Garbage Truck Purchase Decision To show the cell checking, put a check here: x Percent Correct this page 0%
Type your name here, Last Name First Grade in Points (All Sheets) 0.00
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:
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 positive.
Check
Grade
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0
14

Exercise 17.3

City Garbage Truck Purchase Decision To show the cell checking, put a check here: x Percent Correct this page 0%
Type your name here, Last Name First Grade in Points (All Sheets) 0.00
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
Usual Alternate 1 Alternate 2
The city can borrow money (discount rate) at: 7.00% 7.50% 6.50%
Inflation (next 4 years) is expected to average: 3.00% 4.00% 1.00%
Note: all the dollar amounts are in this year's dollar (constant dollar).
Should the city buy the trucks and which lender should it use?
Answer:
Calculation:
Ordinary Lender Real Dollars Nominal Doll. Present value at
Description Time Costs/Benefits Costs/Benefit 7.00% 7.50% 6.50% Check Grade
Purchase 0 -400,000 0 0 0 0
Benefits 1 90,000 0 0 0 0
Benefits 2 90,000 0 0 0 0
Benefits 3 90,000 0 0 0 0
Benefits 4 90,000 0 0 0 0
Residual 4 100,000 0 0 0 0
Total Net PV 0 0 0
Alternate Lender 1 Real Dollars Nominal Doll. Present value at
Description Time Costs/Benefits Costs/Benefit 7.50% 7.00% 6.50%
Purchase 0 -400,000 0 0 0 0
Benefits 1 90,000 0 0 0 0
Benefits 2 90,000 0 0 0 0
Benefits 3 90,000 0 0 0 0
Benefits 4 90,000 0 0 0 0
Residual 4 100,000 0 0 0 0
Total Net PV 0 0 0
Alternate Lender 2 Real Dollars Nominal Doll. Present value at
Description Time Costs/Benefits Costs/Benefit 6.50% 7.00% 7.50%
Purchase 0 -400,000 0 0 0 0
Benefits 1 90,000 0 0 0 0
Benefits 2 90,000 0 0 0 0
Benefits 3 90,000 0 0 0 0
Benefits 4 90,000 0 0 0 0
Residual 4 100,000 0 0 0 0
Total Net PV 0 0 0 0
0
82
Select a solution: (mark)
The usual lender should be used because she offers a positive NPV.
Alternate lender 1 should be used because he offers the highest NPV.
The garbage trucks shouldn't be purchased because there is a chance there will be a negative NPV.
Alternate lender 2 should be used because most scenarios have a positive NPV and she offers the highest NPV for each scenario.
Any solution is as good as any other.

Solution 2

Chapter 16 solution 16.2 City Garbage Truck Purchase Decision
A city has learned that by buying larger garbage trucks, labour 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 benfit incur at the end of the year, should the city buy the trucks?
Answer:
Calculation:
Real Dollars Nominal Doll. Present value
Description Time Costs/Benefits Costs/Benefit
Purchase 0 -400,000 -400,000 -400,000
Benefits 1 90,000 92,700 86,636
Benefits 2 90,000 95,481 83,397
Benefits 3 90,000 98,345 80,279
Benefits 4 90,000 101,296 77,278
Residual 4 100,000 112,551 85,865
Total Net PV 13,454
Select one:
The city should not buy the trucks because the net present value of the decision is positive.
x The city should buy the trucks because the net present value of the decision is positive.

Solution 3

City Garbage Truck Purchase Decision
Question:
A city has learned that by buying larger garbage trucks, labour 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
Usual Alternate 1 Alternate 2
The city can borrow money (discount rate) at: 7.00% 7.50% 6.50%
Inflation (next 4 years) is expected to average: 3.00% 4.00% 1.00%
Note: all the dollar amounts are in this year's dollar (constant dollar).
Should the city buy the trucks and which lender should it use?
Answer:
Calculation:
Ordinary Lender Real Dollars Nominal Doll. Present value at
Description Time Costs/Benefits Costs/Benefit 7.00% 7.50% 6.50%
Purchase 0 -400,000 -400,000 -400,000 -400,000 -400,000
Benefits 1 90,000 92,700 86,636 86,233 87,042
Benefits 2 90,000 95,481 83,397 82,623 84,182
Benefits 3 90,000 98,345 80,279 79,164 81,415
Benefits 4 90,000 101,296 77,278 75,850 78,740
Residual 4 100,000 112,551 85,865 84,278 87,488
Total Net PV 13,454 8,148 18,867
Alternate Lender 1 Real Dollars Nominal Doll. Present value at
Description Time Costs/Benefits Costs/Benefit 7.50% 7.00% 6.50%
Purchase 0 -400,000 -400,000 -400,000 -400,000 -400,000
Benefits 1 90,000 93,600 87,070 87,477 87,887
Benefits 2 90,000 97,344 84,235 85,024 85,824
Benefits 3 90,000 101,238 81,492 82,640 83,810
Benefits 4 90,000 105,287 78,839 80,323 81,842
Residual 4 100,000 116,986 87,599 89,248 90,936
Total Net PV 19,235 24,712 30,299
Alternate Lender 2 Real Dollars Nominal Doll. Present value at
Description Time Costs/Benefits Costs/Benefit 6.50% 7.00% 7.50%
Purchase 0 -400,000 -400,000 -400,000 -400,000 -400,000
Benefits 1 90,000 90,900 85,352 84,953 84,558
Benefits 2 90,000 91,809 80,944 80,190 79,445
Benefits 3 90,000 92,727 76,764 75,693 74,642
Benefits 4 90,000 93,654 72,800 71,448 70,128
Residual 4 100,000 104,060 80,889 79,387 77,920
Total Net PV -3,251 -8,329 -13,306
Select a solution:
The usual lender should be used because she offers a positive NPV.
Alternate lender 1 should be used because he offers the highest NPV.
The garbage trucks shouldn't be purchased because there is a chance there will be a negative NPV.
Correct Answer Alternate lender 2 should be used because most scenarios have a postive NPV and she offers the highest NPV for each scenario.
Any solution is as good as any other.

Grade Worksheet

1.5 Total Points Available Item Grade Weight x A mark here makes the numbers in the grade calculation visible.
0.25 Base Points (for trying this exercise)
0 Manual Points
1.25 Points to be graded
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0 Graded Points
If these cells are blank, there are no cells requiring manual grading
0.25 Initial Grade 0
0.1 Minimum Earned Points
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