1) Tom Thurlow wants to buy a boat but is short of cash. Two alternatives are available: Tom can accept $2,000 per year from his brother for partial ownership in the boat, or he can earn money by renting the boat to others. Rental income would be $2,500 per year. Under either alternative, the boat will last eight years. If Tom rents the boat out, he will have to pay $3,000 to overhaul the engine at the end of the fourth year.
Which alternative should Tom select, assuming that the cost of capital is 12% and that only quantitative considerations are involved?
2) Net Present Value Used to Rank Alternatives
Taglioni's Pizza Company has to choose a new delivery car from among three alternatives. Assume that gasoline costs $1.30 per gallon and that the firm's cost of capital is 12%. The car will be driven 12,000 miles per year.
Car 1 Car 2 Car 3
Cost 12,000 4,000 8,000
Mileage per gallon 40 8 12
Useful life 5 yrs 5yrs 5yrs
Salvage value 2,000 500 1,000
Required:
1. Which car should the company purchase?
2. How would your answer change if the price of gasoline increased to $2 per gallon?