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

Question

You have been asked by the president of your company to evaluate the proposed acquisition of a new special-purpose truck for $60,000. The truck falls into the MACRS 3-year class, and it will be sold after three years for $20,600. Use of the truck will require an increase in NWC (spare parts inventory) of $2,600. The truck will have no effect on revenues, but it is expected to save the firm $20,200 per year in before-tax operating costs, mainly labor. The firm’s marginal tax rate is 34 percent. What will the cash flows for this project be?

Explanation / Answer

Year 0 Cash Flow = - Truck Cost - increase in NWC

Year 0 Cash Flow = -60000 - 2600

Year 0 Cash Flow = -62600

Year 1 cash Flow = Saving before-tax operating costs,*(1-tax rate) + Depreciation * tax rate

Year 1 cash Flow = 20200*(1-34%) + 60000*33.33%*34%

Year 1 cash Flow = $ 20,131.32

Year 2 cash Flow = Saving before-tax operating costs,*(1-tax rate) + Depreciation * tax rate

Year 2 cash Flow = 20200*(1-34%) + 60000*44.45%*34%

Year 2 cash Flow = $ 22,399.80

Terminal Value = Post tax salvage Value + Working capital recovered

Terminal Value = (20600 - 34%*(20600 - 60000*(1-(33.33% +44.45%+ 14.81%)))) + 2600

Terminal Value = $ 17,707.64

Year 3 cash Flow = Saving before-tax operating costs,*(1-tax rate) + Depreciation * tax rate + terminal value

Year 3 cash Flow = 20200*(1-34%) + 60000*14.81%*34% + 17707.81

Year 3 cash Flow = $ 34,061.05

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