Question 7 15 Marks Walt Wallace Construction Enterprises is

Question 7 (15 Marks) Walt Wallace Construction Enterprises is investigating the purchase of a new dump truck. Interest is 9%. The cash flows for two likely models are as follows: Salvage Value ($) 10,000 30,000 Model First Cost Annual OperatingAnnual Life 50,000 80,000 Cost ($) 2,000 1,000 Income (S) 9,000 12,000 10 vears 10 vears (a) Using present worth analysis, decide which truck the firm should buy, and explain why. (b) Before the construction company can close the deal, the dealer sells out of Model B and cannot get any more. What should the firm do now and why?

Solution

Present worth Model A

PW_A = -50000 -2000(P/A, 9%, 10) +9000(P/A, 9%,10) + 10000(P/F, 9%, 10)

= -50000 -2000× 6.418 + 9000×6.418 + 10000×0.4224

= -50000 - 12836 + 57762 + 4224

= - $ 850

Present worth of B

PW_B = -80000 -1000(P/A, 9%,10) + 12000(P/A, 9%, 10) +30000(P/F, 9%, 10)

= -80000 -1000×6.418 + 12000×6.418 +30000×0.4224

= -80000 - 6418 + 77016 + 12672

= $3270

Present worth of Model B is greater than the present worth of A. Hence model B must be selected.

b. Present worth of A is negative hence it must be rejected.

Since PW of A is negative thus NPV will be negative that is the company is not able to earn what it invested.