Jane’s Auto Care is considering the purchase of a new tow truck. The garage doesn’t currently have a tow truck, and the $60,000 price tag for a new truck would rep- resent a major expenditure. Jane Austen, owner of the garage, has compiled the estimates shown on the next page in trying to determine whether the tow truck should be purchased.
Initial cost
$60,000
Estimated useful life
8 years
Net annual cash flows from towing
$8,000
Overhaul costs (end of year 4)
$6,000
Salvage value
$12,000
Jane’s good friend, Rick Ryan, stopped by. He is trying to convince Jane that the tow truck will have other benefits that Jane hasn’t even considered. First, he says, cars that need tow- ing need to be fixed. Thus, when Jane tows them to her facility, her repair revenues will increase. Second, he notes that the tow truck could have a plow mounted on it, thus saving Jane the cost of plowing her parking lot. (Rick will give her a used plow blade for free if Jane will plow Rick's driveway.) Third, he notes that the truck will generate goodwill; people who are rescued by Jane’s tow truck will feel grateful and might be more inclined to use her service station in the future or buy gas there. Fourth, the tow truck will have “Jane’s Auto Care” on its doors, hood, and back tailgate—a form of free advertising wherever the tow truck goes. Rick estimates that, at a minimum, these benefits would be worth the following.
Additional annual net cash flows from repair work
$3,000
Annual savings from plowing
750
Additional annual net cash flows from customer “goodwill”
1,000
Additional annual net cash flows resulting from free advertising
750
The company’s cost of capital is 9%.
Instructions
(a) Calculate the net present value, ignoring the additional benefits described by Rick. Should the tow truck be purchased?
(b) Calculate the net present value, incorporating the additional benefits suggested by Rick. Should the tow truck be purchased?
(c) Suppose Rick has been overly optimistic in his assessment of the value of the ad- ditional benefits. At a minimum, how much would the additional benefits have to be worth in order for the project to be accepted?
