The City of Miami 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 several trucks. The truck A, which costs $ 78,000, is top-of-the-line equipment. The truck has a life of eight years, suppose that the engine is rebuilt in the fifth year. Maintenance costs of $4,000 a year are expected in the first four years, followed by total maintenance and rebuilding costs of $15,000 in the fifth year. During the last three years, maintenance costs are expected to be $6,000 a year. At the end of eight years the truck will have an estimated scrap value of $12,000.
The trucks B cost $65,000 a truck. Maintenance costs for the truck will be higher. In the first year they are expected to be $2,000, and this amount is expected to increase by $1,000 a year by the eighth year. In the fourth year the engine will require to be rebuilt, and this will cost the company $10,000 in addition to maintenance costs in that year. At the end of eight years the truck will have an estimated scrap value of $7,000.
a) What are the relevant cash flows related to the trucks?
b) If the City of Miami's opportunity cost of funds is 8%, which truck should it accept? Ignore tax considerations, Due to the city pays no taxes.
c) If its opportunity cost were 15% would your answer change?