Question 2 (18 marks)

Harper Ltd provides a solid waste collection service in a large metropolitan area. Harper is considering the purchase of several new trucks to replace an equal number of old trucks now in use. The new trucks would cost $650,000, but they would require only one operator per truck (compared to two operators for the trucks now being used), as well as provide other cost savings. A comparison of total annual cash operating costs between the old trucks that would be replaced and the new trucks is provided below:

Old Trucks

Salaries - operators $140,000 Fuel 34,000 Insurance 6,000 Maintenance 10,000 Total annual cash operating costs $180,000

New Trucks

$ 70,000 11,000 25,000 4,000 $110,000

If the new trucks are purchased, the old trucks will be sold to a company in a nearby city for $65,000. These old trucks cost $300,000 and have a current book value of $120,000.

If the new trucks are not purchased, the old trucks will be used for seven more years and then sold for an estimated $15,000 scrap value. However, to keep the old trucks operating, extensive repairs will be needed and will cost $170,000 per year. These repairs will be expensed for tax purposes in the year incurred. Moreover, Harper will take depreciation deduction for tax purposes on the old trucks of $60,000 a year over the next two years.

Harper estimates that the new trucks have a useful life of seven years and can be sold for $80,000 at theend of their useful life. Harper's tax rate is 30%, and its after-tax cost of capital is 14%. For tax purposes, Harper would depreciate the new truck over five years using straight-line depreciation and assuming zero salvage value.

Required:

Determine whether the new trucks should be purchased using the net present value method. Also explain both quantitative and qualitative considerations in the purchase decision.