You have been asked the president of your company to evaluate the proposed acqui

Question

You have been asked the president of your company to evaluate the proposed acquisition of a new-purpose truck. Since you are not a expert on industrial vehicles, you hire a consulting firm to make recommendations. The consultant charged you $500 and recommended the purchase of a model CP8 truck. The truck's basic price is $50,000, and it will cost another $10,000 to modify it for special use by your firm. The truck falls into the MACRS 3-year class, and it will be sold after three years for $20,000. Use of the truck will require an increase in your net working capital of $20,000. The truck will have no effect on revenues, but it is expected to sace the firm $20,000 per year in before-tax operating costs, mainly labor. The firm's marginal rate is 40%. The rates for MACRS 3-year assets are 33% in year one, 45% in year two, 15% in year three, and 7% in year four.

What is the net investment required to undertake this project?

What is the net cash flow in year three, including any final year adjustment?(Final year adjustment are called terminal year cash flow in the textbook?

Explanation / Answer

Q1) Trucks base price $50,000 Cost of modification $10,000 Net working capital $20,000 Net Investment required $80,000 Q2) cash flows per year = (savings - depreciation) X (1-taxrate) Year Depreciation per year Book value savings per year Marginal tax rate cash flow per year 1 33% $16,500 $20,000 0.4 2100 2 45% 22,500 $20,000 0.4 -1500 3 15% $7,500 $20,000 0.4 7500 4 7% $3,500 $20,000 0.4 9900 Net cash flows in year three = $ 7,500 + salvage value($ 20,000) Net cash flows in year 3 = $ 27,500

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