Assume that the Greenvale Senior’s Society purchased a bus two years ago for $200,000. Today, a similar bus can be purchased for $175,000. Purchasing a new bus today will save the Society $5,000 per year in operational costs compared to the bus purchased two years ago. Each bus has an estimated useful life of five years and will be driven 100,000 km per year. If the new bus is purchased, the maintenance contract with the seller will be reduced from $20,000 per 100,000 km of use to $18,000. The old bus can be sold for $140,000 in one year’s time. In the meantime, it can be used as a temporary replacement vehicle for the new bus if needed. Assume that no income or other taxes apply and that the maintenance contract will be paid at the beginning of each year. Identify the sunk costs at the point of decision. Calculate the maximum purchase price that the Society would be willing to pay for the new bus. State any additional assumptions you make.
Assume that the Greenvale Senior’s Society purchased a bus two years ago for $200,000. Today, a similar bus can be purchased for $175,000. Purchasing a new bus today will save the Society $5,000 per year in operational costs compared to the bus purchased two years ago. Each bus has an estimated useful life of five years and will be driven 100,000 km per year. If the new bus is purchased, the maintenance contract with the seller will be reduced from $20,000 per 100,000 km of use to $18,000. The old bus can be sold for $140,000 in one year’s time. In the meantime, it can be used as a temporary replacement vehicle for the new bus if needed. Assume that no income or other taxes apply and that the maintenance contract will be paid at the beginning of each year. Identify the sunk costs at the point of decision. Calculate the maximum purchase price that the Society would be willing to pay for the new bus. State any additional assumptions you make.
Chapter10: Capital Budgeting: Decision Criteria And Real Option
Section: Chapter Questions
Problem 17P
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- Assume that the Greenvale Senior’s Society purchased a bus two years ago for $200,000. Today, a similar bus can be purchased for $175,000. Purchasing a new bus today will save the Society $5,000 per year in operational costs compared to the bus purchased two years ago. Each bus has an estimated useful life of five years and will be driven 100,000 km per year. If the new bus is purchased, the maintenance contract with the seller will be reduced from $20,000 per 100,000 km of use to $18,000. The old bus can be sold for $140,000 in one year’s time. In the meantime, it can be used as a temporary replacement vehicle for the new bus if needed. Assume that no income or other taxes apply and that the maintenance contract will be paid at the beginning of each year.
- Identify the sunk costs at the point of decision.
- Calculate the maximum purchase price that the Society would be willing to pay for the new bus. State any additional assumptions you make.
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