Question

20. The Scampini Supplies 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 6 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

1. What is the optimal number of years to operate the truck? Do not round intermediate calculations. Round your answers to the nearest whole number.

__years

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

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

Answer 1

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

Lets find the Net Present Value of operating the truck for each of the 5 years:

Net Present Value is highest at $3,827.27 when the truck is operated for 5 years. Hence, the optimal number of years to operate the truck is 5 years.

Introduction of salvage value

Salvage Value is an cash-inflow for the project. If the salvage value is excluded, Net Present Value reduces for the years 1 to 4 as can be seen in above table. The Net Present value becomes negative without the salvage value. Thus, with introducing salvage value, Net Present Value and consequently IRR will only increase.

Answer is III. No. Salvage possibilities could only raise NPV and IRR.

Workings: