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. If the City of San Jose's opportunity cost of funds is 8 percent, which bid should it accept? Ignore tax considerations, because the city pays no taxes.
b. If its opportunity cost were 15 percent, would your answer change?