Question

Speedy Pty Ltd operates a suburban delivery business. It is considering the replacement of a 2-ton van with a 3-ton van. Details of the respective vehicles are as follows:

2-ton truck

Remaining life3 years

Salvage Value now$4,000

Salvage Value in 3 years$0

Written down value now$6,600

Annual Depreciation for tax purposes$2,200

Annual net cash flows before tax$12,000

3-ton truck

Estimated life4 years

Salvage Value in 4 years$2,000

Annual Depreciation for tax purposes$6,000

Cost$24,000

Annual net cash flows before tax$20,000

The after-tax cost of capital 10%pa and the tax rate is 30%.

Management is considering the following alternatives: Replace now or Replace in three years. Which alternative should be accepted? Explain your decision.

Answer 1

Assume Management is considering using 2-ton truck :

• EBIT = Annual net cash flows before tax - Annual Depreciation  
• Tax Paid = EBIT * Tax Paid = EBIT * 0.3
• Operating Cash Flow = Annual net cash flows before tax - Tax PaidV
• PV of Operating Cash Flow =  Operating Cash Flow / ( 1 + Cost of Capital) ^ Year Here Cost of Capital = 10%
• NPV = Sum of PV of Operating Cash Flow

So NPV of considering using 2-ton truck = 22,530.88

Speedy Pty Ltd operates a suburban delivery business. It is considering the replacement of a 2-ton van with a 3-ton van. Details of the respective vehicles are as follows:

2-ton truck

Remaining life3 years

Salvage Value now$4,000

Salvage Value in 3 years$0

Written down value now$6,600

Annual Depreciation for tax purposes$2,200

Annual net cash flows before tax$12,000

Now Speedy Pty Ltd considering replaing 02 Ton truck with a 03 Ton Truck :

First we will calculate after tax proceed from sale of Old Truck :

Written down value of Truck = $6,600

Sales Value = $4,000

As Book Value Higher than Sales Value there will be No Tax Applicable.

after tax proceed from sale of Old Truck = $4,000

Cost of New Truck =

Estimated life = 4 years

Cost of New Truck = $24,000

Annual Depreciation for tax purposes= $6,000

So Depreciation Claimed in 04 Years = Annual Depreciation* Estimated life = 6000 * 4 = 24,000

Remaining book value = Cost of New Truck - Depreciation Claimed in 04 Year = 24,000 - 24,000 = 0

Salvage Value in 4 years $2,000

So after 4 Years $2,000 will be taxable

Total Tax = Salvage Value* Tax Rate = 2000 * 0.3 = 600

After Tax Salvage Value = Salvage Value - Total Tax = 2000 - 600 = 1400

• EBIT = Annual net cash flows before tax - Annual Depreciation  
• Tax Paid = EBIT * Tax Paid = EBIT * 0.3
• Operating Cash Flow = Annual net cash flows before tax - Tax Paid
  • For Year 0 : Sum of Proceeds from Sales of Old Machine & Costof New Machine
  • Fpr Year 04 :Annual net cash flows before tax - Tax Paid + Proceeds from Sales of New Machine after 04 Years
• PV of Operating Cash Flow =  Operating Cash Flow / ( 1 + Cost of Capital) ^ Year Here Cost of Capital = 10%
• NPV = Sum of PV of Operating Cash Flow

NPV of considering replaing 02 Ton truck with a 03 Ton Truck : 31040.09

Since NPV of Replacing  02 Ton truck with a 03 Ton Truck is Higher company should go for Replacement Now (Ans)