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 $6,000 to modify the van to carry the company's products. Cost savings from use of the 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 $5,000 at the inception of the project, but this amount will be recaptured at the end of year five. What is the new van are incremental free cash flow for year one?

Explanation / Answer

In year 1, Annual Savings = 28,000 from new van.

Depreciation = (80,000 + 6,000) / 5 = 17,200

Earnings before taxes (EBT) = 28,000 - 17,200 = 10,800

Tax (35%) = 35% x 10,800 = 3,780

Net Income = 10,800 - 3,780 = 7,020

Incremental Cash Flow = Net Income + Depreciation = 24,220

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