CAPITAL BUDGETING:

Garbage Truck Mini-Case I

The City of Prince George is considering investing in a new automated garbage collection
system. Under the proposed new system, garbage would be collected using a
mechanical arm on a garbage truck instead of workers lifting cans and bags by hand. To
put this system into place, the City would have to replace its fleet of 10 garbage trucks
with new automated trucks.
Each new automated garbage truck would cost $132,000 and would have an expected
useful life of 6 years. The salvage value expected at the end of 6 years is $4,000 per
truck.
The old garbage trucks could be used for 6 more years. Each old truck has a current
salvage value of $35,000, but if held to the end of its useful life, would have no final
salvage value.
The proposed new automated garbage collection system is expected to reduce labour
costs (since fewer garbage collectors are needed) and also to reduce job-related injuries
to garbage collectors. Prince George’s municipal government estimates that it would
save a total of $296,000 annually in labour costs and Workers’ Compensation Board
(WCB) premiums if it were to replace the entire fleet of garbage trucks.
Adoption of an automated collection system would require an immediate investment in
net working capital of $24,000 (mostly in the form of parts inventories). This working
capital would be recovered fully at the end of the project.
Homeowners would have to purchase new garbage “carts” from the City to replace their
old garbage cans. Homeowners would be billed for these carts on their next water/sewer
assessment one year from now. The City will charge homeowners a price that exceeds
the cost of each cart, which would generate an additional $90,000 in net revenues for the
City one year from now.

The City of Prince George uses a discount rate of 8 percent to evaluate capital investment
projects such as this. The City does not pay taxes.
Relying on an NPV analysis, should the City of Prince George invest in an
automated garbage collection system?
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More complicated problem:
Suppose that the cost savings estimate does not recognize that labour costs and
WCB premiums can be expected to grow at an inflation rate of 2% per year after
the first year. Would your decision change under this new inflation assumption?
MacKenzie Manufacturing Mini-Case II

Bill Ross is an entrepreneur. He owns a small building in MacKenzie, a community in

northern British Columbia, that he bought 6 years ago for $35,000. The current market
value of the building is estimated to be $38,000 and it is expected that market values
would increase at a rate of 4% per year over the next 3 years.
Bill has learned of a new joint Federal and Provincial Government program that offers
new businesses tax free status for three years if they establish a new business in an
economically deprived area. Additionally, Bill has been told by the local municipal
government that it will provide a grant of $5,000 at the end of each year that he operates
his business, since new businesses would help with unemployment and other social
issues in the community. Bill is trying to decide if “the numbers work”.
Several years ago, he traveled to MacKenzie to look around and get a feel for the place.
At that time, he bought his building and spent about $4,000 in travel and other costs.
Today, Bill believes that he could set up his new business in the building he owns, but he
would need to purchase two machines: Machine A would cost $100,000 and be worthless
at the end of 3 years; Machine B would cost $150,000 and would have a salvage value
of $40,000 at the end of 3 years. Bill uses straight-line depreciation in the preparation of
his financial statements.
Bill estimates that unit sales would be 1,000, 3,000 and 2,000 units in years 1,2 and 3
respectively, with each unit having a selling price of $300. Variable costs would be $200
per unit and fixed costs (administration and advertising) are expected to be $50,000 per
year. Because the tax free status ends after 3 years and sales are expected to drop off
drastically after 3 years, Bill has determined that the business would wind down at the
end of 3 years.
Bill estimates that he will need working capital (primarily to finance inventories), and that
the level of working capital required in any given year would be 10% of the following year’s
sales revenues.
Help Bill make a decision if he uses a cost of capital rate of 12% for a business of
this kind. Clearly state any assumptions that you feel are necessary. Also
incorporate sensitivity analysis into your solution.