Beka’s Auto Repair is considering the purchase of a new tow truck. The garage doesn’t currently have a tow truck, and the $65,000 price tag for a new truck would represent a major expenditure for the garage. Beka Grace, owner of the garage, has compiled the following estimates in trying to determine whether to purchase the truck.
Initial cost ............ $65,000
Estimated useful life ......... 8 years
Net annual cash inflows from towing . $9,600
Overhaul costs (end of year 4) .... $6,000
Salvage value .......... $18,000

Beka’s good friend, Josh Michaels, stopped by. He is trying to convince Beka that the tow truck will have other benefits that Beka hasn’t even considered. First, he says, cars that need towing need to be fixed. Thus, when Beka tows them to her facility her repair revenues will increase. Second, he notes that the tow truck could have a plow mounted on it, thus saving Beka the cost of plowing her parking lot. (Josh will give her a used plow blade for free if Beka will plow Josh’s driveway.) Third, he notes that the truck will generate goodwill; that is, people who are rescued by Beka and her tow truck will feel grateful and might be more inclined to use her service station in the future, or buy gas there. Fourth, the tow truck will have “Beka’s Auto Repair” on its doors, hood, and back tailgate—a form of free advertising wherever the tow truck goes.
Josh estimates that, at a minimum, these benefits would be worth the following.
Additional annual net cash flows from repair work ...... $3,600
Annual savings from plowing ............... 600
Additional annual net cash flows from customer “goodwill” .. 1,200
Additional annual net cash flows resulting from free advertising . 500
The company’s cost of capital is 10%.
Instructions
(a) Calculate the net present value, ignoring the additional benefits described by Josh.
Should the tow truck be purchased?
(b) Calculate the net present value, incorporating the additional benefits suggested by Josh. Should the tow truck be purchased?
(c) Suppose Josh has been overly optimistic in his assessment of the value of the additional benefits. At a minimum, how much would the additional benefits have to be worth in order for the project to be accepted?