Question

In: Finance

he Sorensen Supplies Company recently purchased a new delivery truck. The initial cash outflow for the...

he Sorensen Supplies Company recently purchased a new delivery truck. The initial cash outflow for the new truck is $25,000, and it is expected to generate after-tax cash flows of $6,200 per year. The truck has a 5-year expected life. The expected year-end abandonment values (after-tax salvage values) for the truck are given below. The company's WACC is 11%.

Year Annual After-Tax Cash Flow Abandonment Value
0 ($25,000) -
1 6,200 $21,000
2 6,200 18,500
3 6,200 16,500
4 6,200 11,500
5 6,200 0
  1. What is the truck's optimal economic life? Round your answer to the nearest whole number.

       year(s) =

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

    -Select-Yes or No

Solutions

Expert Solution

Solution:

For making judgement we need to calculate the NPV for the truck considering each year as an abdaonment option separately and evaluate it on the basis of highest NPV.

Year 1:

Year 2:

Year 3:

Year 4:

Year 5:

After carefull consideration we found that we need to abandon the truck after 3 years as it has the highest NPV on that term with $2,215.69 i.e., the turck's optimal life is 3 years.

After analysing carefully the impact of abandonment valus we found that not all the time it reduces the NPV/IRR of the truck. Initially it increases and then decreases in the later part. So, its a NO.


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