Lowell Trucking Corporation is planning to purchase a new truck. The cost of the
ID: 2754447 • Letter: L
Question
Lowell Trucking Corporation is planning to purchase a new truck. The cost of the new truck will be $100,000. The new truck will be used for six years, but will require major repairs every two years at a cost of $25,000 each time. During its life of six years, the truck will provide cash inflow of $200,000 each year for years 1 and 2, $170,000 for years 3 and 4, and $140,000 for years 5 and 6. All costs of operating the truck, including taxes, will be $130,000 each year. After six years, the truck will be sold to a junk yard for $5,000. The company's weighted average cost of capital is 12%, and its average tax rate is 30 percent.
What is the NPV and profitability index of the truck purchase decision?
What is the IRR of the truck purchase decision?
Explanation / Answer
Net present value of project = Present value of cash Inflow - Present value of cash outflow
= $2,61,675 - $100,000
= $1,61,675
Present value of cash outflow
Particulars
(at Y= 0) Amount
Cash outflow
$100,000
PVF (Y=0)
1
Present value of cash outflow
$100,000
Present value of cash Inflow = 261675
Particulars
Y=1
Y=2
Y=3
Y=4
Y=5
Y=6
Annual cash inflow
$200,000
$200,000
$170,000
$170,000
$140,000
$140,000
Less- cash operating expenses
$130,000
$130,000
$130,000
$130,000
$130,000
$130,000
Less- Repair expenses
$25,000
$25,000
$25,000
Add- tax saving on depreciation
$5,000
$5,000
$5,000
$5,000
$5,000
$5,000
Add- salvage value (net of tax)
$3,500
Cash inflow
$75,000
$50,000
$75,000
$50,000
$75,000
$53,500
PVF (12%)
0.893
0.797
0.712
0.636
0.567
0.507
PV of cash inflow
$66,975
$39,850
$53,400
$31,800
$42,525
$27,125
Depreciation ( assume straight line)
Depreciation = cost of truck- salvage value / life
= 100000 - 0 / 6 = 16667
Tax savings on depreciation = 16667 * 30% = 5000
Sale value of truck at end = $5,000
WDV at end = 0
Profit on sale = 5000
Tax on profit = 1500
Sale value net of tax = 3500
Profitability index = present value of cash inflow / present value of cash outflow
= 261675 / 100000
= 2.61675
IRR of truck
PVIFA for 6years= cash outflow / cash inflow
= 100000 / 43612.5
=2.29
IRR= 35%
Particulars
(at Y= 0) Amount
Cash outflow
$100,000
PVF (Y=0)
1
Present value of cash outflow
$100,000
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