The City of San Jose must replace a number of its concrete-mixer trucks with new trucks.

It has received two bids and has evaluated closely the performance characteristics of the

various trucks. The Rockbuilt truck, which costs $74,000, is top-of-the-line equipment.

The truck has a life of eight years, assuming that the engine is rebuilt in the fifth year.

Maintenance costs of $2,000 a year are expected in the first four years, followed by total

maintenance and rebuilding costs of $13,000 in the fifth year. During the last three years,

maintenance costs are expected to be $4,000 a year. At the end of eight years the truck will

have an estimated scrap value of $9,000.

A bid from Bulldog Trucks, Inc., is for $59,000 a truck. Maintenance costs for the truck

will be higher. In the first year they are expected to be $3,000, and this amount is expected

to increase by $1,500 a year through the eighth year. In the fourth year the engine will need

to be rebuilt, and this will cost the company $15,000 in addition to maintenance costs in

that year. At the end of eight years the Bulldog truck will have an estimated scrap value of

$5,000.

a. What are the relevant cash flows related to the trucks of each bidder? Ignore tax considerations
because the City of San Jose pays no taxes.

b. Using the figures determined in Part (a), what are the cash-flow savings each year that

can be obtained by going with the more expensive truck rather than the less expensive

one? (That is, calculate the periodic cash-flow differences between the two cash-flow

streams – assume that any net cost savings are positive benefits.)

4. US Blivet is contemplating the purchase of a more advanced blivet-extrusion machine to

replace the machine currently being used in its production process. The firm’s production

engineers contend that the newer machine will turn out the current volume of output

more efficiently. They note the following facts in support of their contention.

l The old machine can be used for four more years. It has a current salvage value of

$8,000, but if held to the end of its useful life, the old machine would have an estimated

final salvage value of $2,000. This is the final year that tax depreciation will be taken on

the machine, and the amount of depreciation is equal to the machine’s remaining

depreciated (tax) book value of $4,520.

l The new, advanced blivet-extrusion machine costs $60,000. Its final salvage value is

projected to be $15,000 at the end of its four-year useful life. The new machine falls into

the three-year property category for MACRS depreciation.

l The new machine will reduce labor and maintenance usage by $12,000 annually.

l Income taxes on incremental profits are paid at a 40 percent rate.

Calculate the expected annual incremental cash flows for years 1 through 4, as well as

the estimated initial cash outflow.