Ajax Rentals has an opportunity to purchase a truck for $130000 with a useful li

Question

Ajax Rentals has an opportunity to purchase a truck for $130000 with a useful life of 5 years and with a $20000 salvage value. Spare parts totaling $4000 must be purchased when the truck is acquired and this cost will be recovered at the end of the truck's useful life. After two years a $25000 major overhaul is needed. Ajax can generate $75000 a year in delivery revenues, and operating expenses will be $35000 a year, without depreciation. Cost of capital is 8%.

What is the present value of cash outflows? Assuming Ajax has a 40% tax rate, would it accept the project?

Explanation / Answer

Annual revenue 75000 Less: Annual O&M expense 35000 Net annual savings 40000 Less: Dep (130000-20000)/5 22000 Net income before tax 18000 Less: Tax @ 40% 7200 Net income after tax 10800 Add: Depreciation 22000 Annual cash inflows 32800 Annuity PVF at 8% fr 5 years 3.9927 Present value of inflows 130960.6 Add: Present value of salvage and Spare parts 16334.4 (20000+4000)*0.6806 Present value of total inflows 147295 Less: Initial investment 130000 Less: Spare parts purchased 4000 Less: Present value of overhauling 21432.5 (25000*0.8573) Net present value -8137.54

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