Your company is considering the replacement of an old delivery van with a new on

Question

Your company is considering the replacement of an old delivery van with a new one that is more efficient. The old van cost $40,000 when it was purchased 5 years ago.  The old van is being depreciated using the simplified straight line method over a useful life of 8 years.  The old van could be sold today for $7,000.  The new van has an invoice price of $80,000 and it will cost $6000 to modify the van to carry the company's products.  Cost savings from the use of the new van are expected to be $28,000 per year for 5 years, at which time the van will be sold for its estimated salvage value of $18,000.  The new van will be depreciated using the simplified straight line method over its 5 year useful life.  The company's tax rate is 35%.  Working capital is expected to increase by $5000 at the inception of the project, but this amout will be recaptured at the end of year five.  What is the incremental free cash flow for year one?

A. $18,875

B. $24,220

C. $22, 305

D. $19985

Explanation / Answer

investment in the new van 75000
Modification Cost 5000
Working Capital requirement 3000
less: Proceeds from sale -5000
Incremental Cash at the beginning of the year 1 78000


Cost savings 22000
Less:Taxes on the above -7700
Net Cost savings 14300
Add: Depreciation
(75,000+5,000 - 15,000) / 5 13000
Incremental Cash at the end of the year 1 27300

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