You have been asked by the president of your company to evaluate the proposed acquisition of a new special purpose truck. The truck basic price is $50,000, and it will cost another $10,000 to modify it for speccial use by the firm. The truck falls in the MACRS three-year class, and it will be sold after three years for 20,000.Use of the truck will required an increased in net operating working capital (spare parts inventory) of 2,000. The Truck will have no effect in revenues, but is expected to save the firm $20,000 per year before-tax operationg costs, mainly labor. The firms marginal tax rate is 40%.
* What is the net investment in the truck (year 0 net cash flow)
* What is the total(non-operating) cash flow at the end of year 3?
*The truc cost of capital is 10%. What is it’s NPV?
Answer:
a
Price ($50,000)
Modification (10,000)
Change in NWC (2,000)
Net Cost ($62,000)
B
.
First of all we find DTS as follow
| Year | Value | Rate | Depriciation | DTS Dep*0.40 |
| 1 | 60000 | 0.33 | 19800 | 7920 |
| 2 | 60000 | 0.45 | 27000 | 10800 |
| 3 | 60000 | 0.15 | 9000 | 3600 |
Now we will find opearting cash flow as under
| Year 1 | Year 2 | Year 3 | |
| After-tax savings | 12000 | 12000 | 12000 |
| Depreciation shield | 7920 | 10800 | 3600 |
| Operating cash flow | 19920 | 22800 | 15600 |
* The after-tax cost savings is $20,000(1 – T) = $20,000(0.6)
= $12,000.
**The depreciation expense in each year is the depreciable basis, $62,000, times the MACRS allowance percentage of 0.33, 0.45, and 0.15 for Years 1, 2 and 3, respectively. The depreciation shield is calculated as the tax rate (40%) times the depreciation expense in each year. So DTS is 7920,10800 and 3600 for 3 year
* The after-tax cost savings is $20,000(1 – T) = $20,000(0.6)
= $12,000.
Salvage value $20,000
Tax on SV* (6320)
Return of NWC 2,000
Additional end-of-project cash flow $15680
*Tax on SV = ($20,000 – $4200)(0.4) = $6320.
The remaining Book Value in Year 4 = $60,000(0.07) = $4200.
- Now we will find NPV as follow
| Year | Cash Flow |
Last Year CF |
Net Cash Flow |
PV Factor @10% |
Prasent Value |
| 0 | -62000 | -62000 | 1 | -62000 | |
| 1 | 19920 | 19920 | 0.909091 | 18109.09 | |
| 2 | 22800 | 22800 | 0.826446 | 18842.98 | |
| 3 | 15600 | 15680 | 31280 | 0.751315 | 23501.13 |
| -1546.81 |
Answer: The project has a negative NPV, therefore it should not be accepted
