Question

Company recently purchased a new delivery truck. The new truck cost $22,500, and it is expected to generate net after-tax operating cash flows, including depreciation, of $6,250 per year. The truck has a 5-year expected life. The expected salvage values after tax adjustments for the truck are given below. The company's cost of capital is 12.5 percent.

Year/ Annual Operating Cash Flow/ Salvage Value

0/ $22,500/ $22,500

1/ 6,250/ 17,500

2/ 6,250/ 14,000

3/ 6,250/ 11,000

4/ 6,250/ 5,000

5/ 6,250/ 0

a. What is the optimal number of years to operate the truck?

b. Would the introduction of salvage values, in addition to operating cash flows, ever reduce the expected NPV and/or IRR of a project?

I. No. Salvage possibilities could only raise NPV and IRR. II. Yes. Salvage possibilities could only lower NPV and IRR. III. Salvage possibilities would have no effect on NPV and IRR.

Answer 1

Optimal number of years = 3

Year	Cash flow	Salvage	NPV
0	-22500	22,500.00
1	$6,250.00	17,500.00	(1,388.89)
2	$6,250.00	14,000.00	(944.44)
3	$6,250.00	11,000.00	109.05
4	$6,250.00	5,000.00	(593.28)
5	$6,250.00	-	(246.45)

b) I. No. Salvage possibilities could only raise NPV and IRR

(Since salvage represents higher cash flows, more salvage represents higher NPV/IRR)