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

cash outlay to replace existing with new:

100,000*10-25000*10=$ 750,000

Draw a timeline for the replacement project cash flows for years 0 to 5.

If QL&CC requires a 15% discount rate for new investments, should the fleet be replaced?

Fleet should not be replaced see below reason:

old truck new truck    250,000.00    1,000,000.00 purchase 10        5,000.00        400,000.00 salvage value after five years        120,000.00 depreciation per year for 5 years          36,000.00 tax savings @30%    300,000.00        200,000.00 fuel cost assuming for 5 years    400,000.00        150,000.00 maintenanc cost asuming for 5 years Cash flow for new fleet for 5 years Year 1 2 3 4 5 fuel cost      40,000.00          40,000.00           40,000.00     40,000.00     40,000.00 maintenance cost      30,000.00          30,000.00           30,000.00     30,000.00     30,000.00 tax savings    (36,000.00)        (36,000.00)        (36,000.00) (36,000.00) (36,000.00) net cash out flow for operations      34,000.00          34,000.00           34,000.00     34,000.00     34,000.00 Cash flow for old fleet for 5 years Year 1 2 3 4 5 fuel cost      60,000.00          60,000.00           60,000.00     60,000.00     60,000.00 maintenance cost      80,000.00          80,000.00           80,000.00     80,000.00     80,000.00 tax savings    (75,000.00) net cash out flow for operations      65,000.00        140,000.00        140,000.00 140,000.00 140,000.00 The existing fleet will be fully depreciated in one more year but is expected to be serviceable for five more years Salvage value is an investing activity so not shown in cash flow above diffrential cash flow savings by buying new trucks      31,000.00        106,000.00        106,000.00 106,000.00 106,000.00

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