The Queensland Land and Cattle Company (QL&CC) is one of the largest cattle-buye

Question

The Queensland Land and Cattle Company (QL&CC) is one of the largest cattle-buyers in the country. It has buyers at all the major cattle auctions throughout eastern Australia who buy on the company's behalf and then have cattle shipped to Longreach, Queensland, where they are shorted by weight and type before being shipped off to feed lots in Queensland. The company has been considering the replacement of its trucks with a newer, more fuel-efficient fleet for some time, and a local Peterbilt dealer has approached the company with a proposal. The proposal would call for the purchase of 10 new trucks at a cost of $100,000 each. Each new vehicle would be depreciated toward a salvage value of $40,000 over a period of five years. If QL&CC purchases the trucks, it will sell its existing fleet of 10 trucks to the Peterbilt dealer for their current book value of $25,000 per unit. The existing fleet will be fully depreciated in one more year but is expected to be serviceable for five more years, at which time the vehicles would be worth only $5,000 per unit as scrap. The new fleet is much more fuel-efficient and will require only $200,000 in fuel costs compared to $300,000 for the existing fleet. In addition, the new fleet will require minimal maintenance over the next five years, equal to an estimated $150,000 compared to the almost $400,000 that is currently being spent to keep the older fleet running. a. What are the differential operating cash flow savings per year during years 1 to 5 for the new fleet? The firm pays tax at a 30% marginal tax rate. b. What is the initial cash outlay required to replace the existing fleet with new trucks? c. Draw a timeline for the replacement project cash flows for years 0 to 5. d. If QL&CC requires a 15% discount rate for new investments, should the fleet be replaced?

Explanation / Answer

(a) Computation of the differential operating cash flow savings per year during years 1 to 5 for the new fleet.We have,

12,000

(b) Computation of the initial cash outlay required to replace the existing fleet with new trucks.We have,

(c)

(d) Computation of the NPV of the project.We have,

Since, the NPV of the investment is $ 8,307.Therefore, the fleet should be replaced.

Particulars Amount($) Saving in fuel cost (300,000 - 200,000) 100,000 Saving in maintenance costs (400,000 - 150,000) 250,000 Less:Depreciation expenses (100,000 - 40,000)/5

12,000

Net operating income 338,000 Less: tax@30% 338,000 x 30% 101,400 Net operating income after tax 236,600 Add: depreciation 12,000 Differential operating cash flow per year for 5 year 248,600

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