Question

Problem 6 Transco plans on purchasing a bus for $75,000 that will have a capacity of 40 passengers. As an alternative, a larger bus can be purchased for $95,000 that will have a capacity of 50 passengers The salvage value of either bus is estimated to be $8,000 after a 10-year life. If the annual net profit of $400 can be realized per passenger, which alternative should be recommended using a management- suggested interest rate of 15%? Using the actual cost of money at 7%?

Answer 1

Solution:
Cost of 40 passenger bus	75000
Cost of 50 passenger bus	95000
Increases in cost	20000
Cost of capital	15%	(As suggested by management)
Incremental cost of additional capital	3000
Additional Passenger	10	(50-40)
Additional revenue per passenger	400
Incremental revenue by buying larger bus	4000	(400 X 10)
As the salvage value and life remain the same so there is no impact of this
As the incremental revenue increases the incremental cost so buying larger bus will result into additional profit of 1000 as below
Incremental Revenue	4000
Less: Incremental cost	3000
Additional profit	1000
So we suggest to buy the larger bus having capacity of 50 passenger