Question

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

Answer 1

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.