Question

Davis Industries must choose between a gas powered or an electric powered forklift truck for moving materials in its factory. The electric powered truck will cost more, but it will be less expensive to operate; it will cost $22,000 whereas the gas powered will cost $17,500. Davis’s pretax cost of debt 8% and their cost of equity is 18%. The target capital structure is 40% debt and 60% equity. The company’s tax rate is 22%. The life of both trucks is expected to be six years. The net cash inflows for the electric powered truck will be $6,290 per year and those for the gas powered truck will be $5,000 per year.

Calculate the WACC for the project and the NPV, PI, IRR, PB, DPB for each type of truck and decide which to recommend.

Answer 1

Davis pretax cost of Debt = 8%

Therefore, after tax cost of Davis = Pretax cost of Debt*(1-Tax Rate)

= 8*(1-0.22)

= 6.24%

.

.

Therefore , WACC of Davis is 13.296%.

.

NPV of Electric powered truck:

Year	Cash Flows	Cummulative Cash Flows	DF Working	Discounting Factor	Present Value	Cummulative Present Value
0	(22,000)	(22,000)	1	1	(22,000.00)	(22,000.00)
1	6,290	(15,710)	1/1.13296^1	0.882643694	5,551.83	(16,448.17)
2	6,290	(9,420)	1/1.13296^2	0.779059891	4,900.29	(11,547.88)
3	6,290	(3,130)	1/1.13296^3	0.687632301	4,325.21	(7,222.68)
4	6,290	3,160	1/1.13296^4	0.606934314	3,817.62	(3,405.06)
5	6,290	9,450	1/1.13296^5	0.535706745	3,369.60	(35.47)
6	6,290	15,740	1/1.13296^6	0.472838181	2,974.15	2,938.69
				NPV:	2,938.69

.

NPV of Gas powered truck:

Year	Cash Flows	Cummulative Cash Flows	DF Working	Discounting Factor	Present Value	Cummulative Present Value
0	(17,500)	(17,500)	1	1	(17,500.00)	(17,500.00)
1	5,000	(12,500)	1/1.13296^1	0.882643694	4,413.22	(13,086.78)
2	5,000	(7,500)	1/1.13296^2	0.779059891	3,895.30	(9,191.48)
3	5,000	(2,500)	1/1.13296^3	0.687632301	3,438.16	(5,753.32)
4	5,000	2,500	1/1.13296^4	0.606934314	3,034.67	(2,718.65)
5	5,000	7,500	1/1.13296^5	0.535706745	2,678.53	(40.12)
6	5,000	12,500	1/1.13296^6	0.472838181	2,364.19	2,324.08
				NPV:	2,324.08

PI of Electric powered truck = Present Value of Cash Inflows/Present Value of Cash Outflows

= 24,938.69/22,000

= 1.13

.

PI of Gas powered truck = Present Value of Cash Inflows/Present Value of Cash Outflows

= 19,824.08/17,500

= 1.13

.

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Payback period of Electric powered truck = 3 + (3,130/6,290)

= 3 + 0.4976

= 3.4976 years

= 3.5 years (rounded off to two decimal places)

.

Payback period of Gas powered truck = 3 + (2,500/5,000)

= 3 +0.50

= 3.5 years

.

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Discounted Payback period of Electric powered truck = 5 + (35.47/2,974.15)

= 5 + 0.01

= 5.01 years

.

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Discounted Payback period of Gas powered truck = 5 + (40.12/2,364.19)

= 5 + 0.02

= 5.02 years

.

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At IRR,

Present Value of Cash Outflows = Present Value of Cash Inflows

.

IRR of Electric powered truck:

Therefore,

22,000 = 6290/(1+IRR^1) + 6290/(1+IRR^2) + 6290/(1+IRR^3) +6290/(1+IRR^4) +6290/(1+IRR^5) +6290/(1+IRR^6)

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Computing for IRR , we get IRR = 18%

.

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IRR of Gas powered truck:

Therefore,

17,500 = 5000/(1+IRR^1) + = 5000/(1+IRR^2) += 5000/(1+IRR^3) += 5000/(1+IRR^4) += 5000/(1+IRR^5) += 5000/(1+IRR^6)

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Computing for IRR , we get IRR =17.973%