Reference no: EM132002828

Question: Mr. Joe has heating and air conditioning business that was established 25 years ago, Mr. Joe was doing fine for the first 15 year, but with the steady grow of his business he decided that the business is too large as he could successfully supervise.

Mr. Joe business revolves around 20 vans that are on the street, and another 4 for backup (in the shop). The 20 vans are not all out at once. Mr. Joe has 32 technicians whom cover the vans. Each technician is assigned to a van, and each van has one or two technicians assigned to it.

Mr. Joe has tried to use a pool of vans, which requires rotating the vans among technicians, but he found that this caused an increase in his cost due to many reasons such as, drivers were harder on the vehicles, they didn't communicate well with the mechanics, and it stay for longer time in the shop (for maintenance).

The average age of Mr. Joe's fleet of vans has crept up, and it is now 4 years. His vans generally last for 7 years before rotating them among technicians. Mr. Joe is getting more complaints from his technicians about vans spending more time in the shop. He asked his manager and his bookkeeper to analyses the economics of van replacement using 10% interest rate for the time value of money.

After Mr. Joe purchase a van, he sends it to a special vender to install additional parts. The new van cost about $14,000, and installing the special parts cost another $4000, and the inventory cost another $5000. If the van is retired, its inventory can be transferred, but the special parts are worthless.

The annual maintenance costs for a van start at $500 per year and increased by $200 each year thereafter. As the vans age, there will be an additional operating cost begin at $250 and increased by $750 per year thereafter.

Assume a 40% marginal tax rate for combined state and federal income taxes, and use 6% after-tax interest rate. Ignore the capital gain and investment tax credit. What is your recommendation?