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Unformatted text preview: Event 6 Net Worth Approach key Lessons 12 and 13 Pedro's Tree Trimming Business Revisited We now return to Pedro who is thinking of starting a treetrimming service. He will run the service for five years and then dissolve it. Truck Costs He plans on buying three new Ford F150 trucks for the business. The trucks can be purchased for $24,000 each. This cost includes taxes and fees at purchase. The resale value for a truck after five years is estimated at $8000. The following describes the annual operating costs for a single truck. Annual insurance cost is $1200 and annual license and inspection fees are $100. Maintenance cost is $400 in the first year and increase by $200 in each subsequent year. The cost of repairs is zero for the first two years and will be $200 in the third year. In subsequent years the cost will grow by $200 per year. Fuel Costs Fuel costs are $0.15/mile. In addition to job mileage, each truck will drive 2000 miles a year. The round trip to each job averages 20 miles. Shredders In addition to trucks he must purchase wood shredders. He needs one shredder that costs $5000. The shredder must be replaced at the beginning of the third year for a cost of $5000. Shredders have no resale value. Labor Each job requires two trimmers for an 8hour day and $50 in supplies. Tree trimmers earn $15 an hour. The workers are hired hourly. Overhead (office, phone, secretary, etc.) for running the business is 40% of the trimmer labor cost. Pedro will be the manager with an annual salary $30,000. Demand The demand for lawn service is expected to be 250 jobs per year. We will investigate several assumptions regarding revenue. Event Form There is a blank form on Blackboard that will help you get started with this problem. It will be available during the class meeting. 1 Problems For these problems use the Economics addin. Use the Add Project command to create a project with one investment and 15 cash flow components. Put the initial cost and resale of the trucks in the Investment Data row. The resale value of the trucks is expressed as a percentage in the cell indicated as Salvage. Put the remainder of the cash flow components in the Cash Flow Data rows. Enter expenditures as negative numbers and revenues as positive numbers. The start time for a gradient is the first period where the cash flow is nonzero. Added: Pedro's MARR is 15%. For each part, find the NPW, NAW and IRR for the cash flow. Use the Compute Rates command to find the IRR for each case. For part b, find the revenue per job that just yields a 15% return. (Hint: Use Solver to find the revenue that makes the Present Worth cell equal to zero when the MARR is set to 15%.) Solutions to parts a and b Part a. Unit Revenue Present Worth Annual Worth IRR Decision (Accept/Reject) $625 $2810 $838 16.38% Accept b. Yields 15% return: $622 0 0 15% Accept c. $650 $23,761 $7088 26.41% Accept 2 Part a. Unit revenue = $625 Project Definition Name Pedro Periods Life (yrs) Repetitions Study Period Rates (%) 5 MARR(/yr) 15.% 1 5 Present (Life) Uniform (Life) Present (SP) IRR Worth($) 2810 838 2810 16.38% Net Investment Investment Data Amounts Negative for Investments Index Description Amount($) Type Start 1 Truck Cost (72000) Investment 0 End 5 Salvage Factor Fin. NPW($) 33.33% 0.8343 (60068) Cash Flow Data Amounts Negative for Expenditures and Positive for Revenues Index Description Amount($) Type Start End Parameter Factor CF. NPW($) 1 Insurance (3600) Uniform 1 5 1 3.3522 (12068) 2 License (300) Uniform 1 5 1 3.3522 (1006) 3 Fixed Fuel (900) Uniform 1 5 1 3.3522 (3017) 4 Maintenance (1200) Uniform 1 5 1 3.3522 (4023) 5 Maint Grad. (600) Grad 2 5 1 5.7751 (3465) 6 Repairs (600) Uniform 3 5 1 1.7264 (1036) 7 Repairs Grad. (600) Grad 4 5 1 1.5661 (940) 8 Shredder (5000) Single 0 *** *** 1.0000 (5000) 9 Pedro (30000) Uniform 1 5 1 3.3522 (100565) 10 Shredder (5000) Single 2 *** *** 0.7561 (3781) 11 Trimmers 12 Overhead 13 Supplies 14 Variable Fuel 15 Revenue (60000) Uniform (24000) Uniform (12500) Uniform (750) Uniform 156250 Uniform 1 1 1 1 1 5 5 5 5 5 1 1 1 1 1 3.3522 3.3522 3.3522 3.3522 3.3522 (201129) (80452) (41902) (2514) 523774 3 Part c. Unit revenue = $622 Project Definition Name Pedro Periods Life (yrs) Repetitions Study Period Rates (%) 5 MARR(/yr) 15.% 1 5 Present (Life) Uniform (Life) Present (SP) IRR Worth($) (0) (0) (0) 15.% Net Investment Investment Data Amounts Negative for Investments Index Description Amount($) Type Start 1 Truck Cost (72000) Investment 0 End 5 Salvage Factor Fin. NPW($) 33.33% 0.8343 (60068) Cash Flow Data Amounts Negative for Expenditures and Positive for Revenues Index Description Amount($) Type Start End Parameter Factor CF. NPW($) 1 Insurance (3600) Uniform 1 5 1 3.3522 (12068) 2 License (300) Uniform 1 5 1 3.3522 (1006) 3 Fixed Fuel (900) Uniform 1 5 1 3.3522 (3017) 4 Maintenance (1200) Uniform 1 5 1 3.3522 (4023) 5 Maint Grad. (600) Grad 2 5 1 5.7751 (3465) 6 Repairs (600) Uniform 3 5 1 1.7264 (1036) 7 Repairs Grad. (600) Grad 4 5 1 1.5661 (940) 8 Shredder (5000) Single 0 *** *** 1.0000 (5000) 9 Pedro (30000) Uniform 1 5 1 3.3522 (100565) 10 Shredder (5000) Single 2 *** *** 0.7561 (3781) 11 Trimmers 12 Overhead 13 Supplies 14 Variable Fuel 15 Revenue (60000) Uniform (24000) Uniform (12500) Uniform (750) Uniform 155412 Uniform 1 1 1 1 1 5 5 5 5 5 1 1 1 1 1 3.3522 3.3522 3.3522 3.3522 3.3522 (201129) (80452) (41902) (2514) 520964 Part c. Unit revenue = $650 Project Definition Name Pedro Periods Life (yrs) Repetitions Study Period Rates (%) 5 MARR(/yr) 15.% 1 5 Present (Life) Uniform (Life) Present (SP) IRR Worth($) 23761 7088 23761 26.41% Net Investment Investment Data Amounts Negative for Investments Index Description Amount($) Type Start 1 Truck Cost (72000) Investment 0 End 5 Salvage Factor Fin. NPW($) 33.33% 0.8343 (60068) Cash Flow Data Amounts Negative for Expenditures and Positive for Revenues Index Description Amount($) Type Start End Parameter Factor CF. NPW($) 1 Insurance (3600) Uniform 1 5 1 3.3522 (12068) 2 License 3 Fixed Fuel 4 Maintenance 5 Maint Grad. 6 Repairs 7 Repairs Grad. 8 Shredder 9 Pedro 10 Shredder 11 Trimmers 12 Overhead 13 Supplies 14 Variable Fuel 15 Revenue (300) Uniform (900) Uniform (1200) Uniform (600) Grad (600) Uniform (600) Grad (5000) Single (30000) Uniform (5000) Single (60000) Uniform (24000) Uniform (12500) Uniform (750) Uniform 162500 Uniform 1 1 1 2 3 4 0 *** 1 2 *** 1 1 1 1 1 5 5 5 5 5 5 *** 5 *** 5 5 5 5 5 1 1 1 1 1 1 1 1 1 1 1 1 3.3522 3.3522 3.3522 5.7751 1.7264 1.5661 1.0000 3.3522 0.7561 3.3522 3.3522 3.3522 3.3522 3.3522 (1006) (3017) (4023) (3465) (1036) (940) (5000) (100565) (3781) (201129) (80452) (41902) (2514) 544725 4 d. Pedro is considering a second option that involves outsourcing the jobs to a company that does not deal with the public. That company will charge Pedro $475 for each job. For this option, Pedro only needs one truck he does not need an office, workers or supplies. Moreover, his truck requires only the fixed component of the fuel charge. Pedro will receive his $30,000 annual salary. Evaluate this option with unit revenue of $650 per job using an MARR of 15%. Present Worth_$17,552_____ Annual Worth__$5236____ IRR __41.32%____ Project Definition Name Pedro2 Periods Life (yrs) Repetitions Study Period Rates (%) 5 MARR(/yr) 15.% 1 5 Present (Life) Uniform (Life) Present (SP) IRR Worth($) 17552 5236 17552 41.32% Net Investment Investment Data Amounts Negative for Investments Index Description Amount($) Type Start 1 Truck Cost (24000) Investment 0 End 5 Salvage Factor Fin. NPW($) 33.33% 0.8343 (20023) Cash Flow Data Amounts Negative for Expenditures and Positive for Revenues Index Description Amount($) Type Start End Parameter Factor CF. NPW($) 1 Insurance (1200) Uniform 1 5 1 3.3522 (4023) 2 License (100) Uniform 1 5 1 3.3522 (335) 3 Fixed Fuel (300) Uniform 1 5 1 3.3522 (1006) 4 Maintenance (400) Uniform 1 5 1 3.3522 (1341) 5 Maint Grad. (200) Grad 2 5 1 5.7751 (1155) 6 Repairs (200) Uniform 3 5 1 1.7264 (345) 7 Repairs Grad. (200) Grad 4 5 1 1.5661 (313) 8 Pedro (30000) Uniform 1 5 1 3.3522 (100565) 9 Outsource (118750) Uniform 1 5 1 3.3522 (398068) 10 Revenue 162500 Uniform 1 5 1 3.3522 544725 5 e. Compare the two options described with revenue of $650 per job. The MARR is 15%. Use the Compare Projects command. The option with the smaller initial investment is the defender and the one with the greater initial investment is the challenger. Which option should Pedro select and why? Method 1 Compare Projects. He should choose the first option that has three trucks, rather than the outsourcing option. The first option has a greater NPW (and NAW) than the second. Project Comparison Name Comp1 Dynamic Select MARR 15.% Pedro Study Period 5 Project NPW NAW Pedro 23761.44 7088.41 Pedro2 17551.70 5235.94 Increment Investment Pedro Pedro2 NPW 6209.75 NAW 1852.46 IRR 19.4% Net Investment Method 2 Incremental analysis. We find that the NPW of the incremental investment of the threetruck option over the onetruck option is 19.4%. This is greater than the MARR, so the incremental investment is justified. Cash flow Pedro Pedro2Comp1 Simple Investment Payback(yr): 3.5 MARR(/Yr) 15.% Min. Per. 0 NPW 6209.74 IRR Guess 15.% IRR(/Yr) 19.4% Cash Flow Period Cash Flow Cum. Val. 0 (53000.00) (53000.00) 1 17500.00 (35500.00) 2 12100.00 (23400.00) 3 16300.00 (7100.00) 4 15500.00 8400.00 5 30700.00 39100.00 6 ...
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This note was uploaded on 05/13/2010 for the course ME 01953 taught by Professor Bard during the Spring '10 term at University of Texas.
 Spring '10
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