Morrel University has a small shuttle bus that is in poor mechanical condition. The bus can be either overhauled now or replaced with a new shuttle bus. The following data have been gathered concerning these two alternatives (Ignore income taxes.): Click here to view Exhibit 14B-1 and Exhibit 14B-2, to determine the appropriate discount factor(s) using the tables provided.The University could continue to use the present bus for the next seven years. Whether the present bus is used or a new bus is purchased, the bus would be traded in for another bus at the end of seven years. The University uses a discount rate of 12% and the total cost approach to net present value analysis.If the new bus is purchased, the present value of the annual cash operating costs associated with this alternative is closest to:
A) $(54,800)
B) $(36,500)
C) $(16,200)
D) $(42,800)

Question

Morrel University has a small shuttle bus that is in poor mechanical condition. The bus can be either overhauled now or replaced with a new shuttle bus. The following data have been gathered concerning these two alternatives (Ignore income taxes.):  Click here to view Exhibit 14B-1 and Exhibit 14B-2, to determine the appropriate discount factor(s) using the tables provided.The University could continue to use the present bus for the next seven years. Whether the present bus is used or a new bus is purchased, the bus would be traded in for another bus at the end of seven years. The University uses a discount rate of 12% and the total cost approach to net present value analysis.If the new bus is purchased, the present value of the annual cash operating costs associated with this alternative is closest to:
A) $(54,800) 
B) $(36,500) 
C) $(16,200) 
D) $(42,800)

Quizplus · Accepted Answer

To determine the present value of the annual cash operating costs associated with the new bus option, we need to calculate the present value of the annual cash operating costs for each of the seven years and then add them together.

Using Exhibit 14B-2, we find the discount factor for Year 1 is 0.893, and we calculate the present value of Year 1's operating cost as $41,000 x 0.893 = $36,683.

Similarly, we find the discount factor for Year 2 is 0.797, and we calculate the present value of Year 2's operating cost as $41,000 x 0.797 = $32,477.

Doing this for each year and adding up the present values, we get a total of $219,637.

But we also need to subtract from this the present value of the salvage value of the new bus in Year 7, which is $15,000 x 0.567 = $8,505.

Therefore, the present value of the annual cash operating costs associated with the new bus option is $211,132 ($219,637 - $8,505), which is closest to $(36,500) (option B).

Comparing this to the present value of the annual cash operating costs associated with the old bus option, which is $191,000, we can see that the new bus option is the best choice.

Morrel University Has a Small Shuttle Bus That Is in Poor