Question

H and V Car Rental Corporation is contemplating expanding its short-term rental fleet by 30 automobiles at a cost of $1,000,000. It expects to keep the autos for only two years and to sell them at the end of that period for 55 percent, on average, of what they cost. The plan is to generate $20,000 of incremental revenue per additional auto in each year of operation. The controller estimates that other costs will amount to 20 cents per kilometre on an average of 40,000 kilometres per car per year. She also estimates that the new business will require an investment of $15,000 in additional working capital. The firm is in a 30 percent tax bracket and uses 10 percent as a cost of capital. Calculate the NPV for the project

HINT: CCA = 40% and the final answer & (NPV) will be positive.

Answer 1

NPV = sum of present value of cash inflows - initial investment or cash outflow at year 0

sum of present value of cash inflows = year 1 net cash flow/(1+cost of capital) + year 2 net cash flow/(1+cost of capital)2

Tax on salvage value = (salvage value - book value)*tax rate

book value = cost of automobiles - total depreciation = $1,000,000 - ($400,000 + $240,000) = $1,000,000 - $640,000 = $360,000‬

Tax on salvage value = ($1,000,000*55% - $360,000)*30% = ($550,000 - $360,000)*30% = $190,000*30% = $57,000‬

NPV is $10,785.12.

	Years	0	1	2	Total
	Cost of Automobiles	-$1,000,000	0	0	-$1,000,000
	Addi. Working capital	-$15,000	0	0	-$15,000
	Cost savings	$0	$600,000	$600,000	$1,200,000
Less:	Other costs	$0	$240,000	$240,000	$480,000
Less:	Depreciation	$0	$400,000	$240,000	$640,000
	Pre-tax cash flow	$0	-$40,000	$120,000	$80,000
Less:	Taxes @ 30%	$0	-$12,000	$36,000	$24,000
	After-tax cash flow	$0	-$28,000	$84,000	$56,000
Add back:	Depreciation	$0	$400,000	$240,000	$640,000
Add:	recovery of work. Capital	$0	$0	$15,000	$15,000
Add:	Salvage value	$0	$0	$550,000	$550,000
Less:	Tax on salvage value	$0	$0	$57,000	$57,000
	Net cash flow	-$1,015,000	$372,000	$832,000	$189,000
	NPV	$10,785.12

Calculations