The cost accountant of a large truck fleet is evaluating options for dealing with a large volume of flat tires. Currently, the company repairs tires on the open market by having the driver take the flat tire to the nearest tire dealer. Last year, this cost an average of $30 per flat tire. The volume of flat tires experienced per year was 10,000 last year, and the expected rate of growth in flat tires is 10% per year. However, some feel that flat tire growth will be as low as 5%; others as high as 15%. A complicating factor is that the cost to repair a tire grows an average of 3% per year.
The company has two alternatives. A tire dealer has offered to fix all the company’s flat tires for a fixed rate of $36 per tire over a three-year period. The other alternative is for the company to go into the tire repair business for themselves. This option is expected to require an investment in equipment of $200,000, with a salvage value of $50,000 after three years. It would require an overhead expense of $40,000 per year in the first year, $45,000 the second year, and $50,000 the third year. The variable cost for fixing a flat tire is $12 per tire for the three-year period of analysis. Compare the net present costs using a discount rate of 8% over three years for each of these three options under conditions of tire growth rate ranging from 5% to 15% per year in increments of 1%. What is the best option under each scenario? What risk factors should be considered?