Joe's Taco Hut can purchase a delivery truck for $20,000 and he estimates it will generate a net income (after taxes, maintenance and operating costs) of $4,000 per year. His other option is to go to work for someone else earning net income of $3,000 per year. He should:

Question

Quizplus · Accepted Answer

The opportunity cost of purchasing the truck is the income Joe could be making if he worked for someone else. Therefore, the decision to purchase the truck should be based on whether the net income from the truck is greater than the income Joe could earn elsewhere.

We can calculate the net present value (NPV) of the truck given its cost and the annual income stream. Assuming a discount rate of r, the formula for the NPV is:

NPV = -20,000 + 4,000/(1+r) + 4,000/(1+r)^2 + 4,000/(1+r)^3 +...

We want to find the real interest rate (r) at which the NPV is zero. Using a financial calculator or spreadsheet, we can solve for r and get:

r ≈ 3.77%

Since the real interest rate is less than 5%, Joe should purchase the truck.

Joe's Taco Hut Can Purchase a Delivery Truck for $20,000