Santana Auto Care is considering the purchase of a new tow truck. The garage Compute net present value doesn't currently have a tow truck, and the \($50,000\) price tag for a new truck would considering intangible represent a major expenditure for the garage. Sally Roe, owner of the garage, has com- benefits.

piled the following estimates in trying to determine whether the tow truck should be purchased.

Sally's good friend, Don Kline, stopped by. He is trying to convince Sally that the tow truck will have other benefits that Sally hasn't even considered. First, he says, cars that need towing need to be fixed. Thus, when Sally 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 Sally the cost of plowing her parking lot. (Don will give her a used plow blade for free if Sally will plow Don's driveway.) Third, he notes that the truck will generate goodwill; that is, people who are rescued by Sally and her tow truck will feel grateful and might be more inclined to used her service station in the future, or buy gas there. Fourth, the tow truck will have "Santana Auto Care" on its doors, hood, and back tailgate— form of free advertising wherever the tow truck goes. Don estimates that, at a minimum, these benefits would be worth the following

The company's cost of capital is 9%.

Instructions

(a) Calculate the net present value, ignoring the additional benefits described bv Don.
Should the tow truck be purchased?

(b) Calculate the net present value, incorporating the additional benefits suggested by Don. Should the tow truck be purchased?

(c) Suppose Don has been overly optimistic in his assessment of the value of the additional benefits (perhaps because he wants his driveway plowed). At a minimum, how much would the additional benefits have to be worth in order for the project to be accepted?

Transcribed Image Text:

Initial cost Estimated useful life Annual cash inflows from towing Overhaul costs (end of year 4) Salvage value $50,000 8 years $ 7,000 $ 5,000 $15,000