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 Rock built 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?