Question

Your firm recently purchased a new bulldozer. The bulldozer costs $115,000 and its expected to generate net after-tax operating cash flows, including depreciation, of $60,000 per year for the 4 year that the firm is thinking about keeping it. The expected year-end abandonment values for the plant are given below. The company's cost of capital is 14%. WHat is the optimal economic life?

Cash flow Abandonment Value

(115,000)

60,000 100,000

60,000 55,000

60,000 30,000

60,000 8,000

A. An economic life of 2 years ties with an economic life of 4 years.

B. The EAA method confirm that the economic life is 4 years.

C. The EAA method confirm that the economic life is 3 years.

D. The EAA method confirm that the economic life is 1 years.

E. The EAA method confirm that the economic life is 2 years.

Answer 1

EAA = (NPV * r) / (1 - (1 + r)-n)

where NPV = net present value

r = cost of capital

n = life of bulldozer in years

NPV = sum of present values of cash flows

present value of each cash flow = cash flow / (1 + cost of capital)t

where t = number of years after which the cash flow occurs

The EAA of different abandoment years of the bulldozer is calculated as below :

D. The EAA method confirm that the economic life is 1 years.

This is because the EAA is highest if the bulldozer is abandoned after 1 year

D. The EAA method confirm that the economic life is 1 years.

This is because the EAA is highest if the bulldozer is abandoned after 1 year