(Related to Checkpoint 12.2) (Replacement project cash flows) Madrano\'s Wholesa

ID: 1172610 • Letter: #

Question

(Related to Checkpoint 12.2) (Replacement project cash flows) Madrano's Wholesale Fruit Company located in McAllen, Texas is considering the purchase of a new fleet of tractors to be used in the delivery of fruits and vegetables grown in the Rio Grande Valley of Texas. If it goes through with the purchase, it will spend $440,000 on eight rigs. The new trucks will be kept for 5 years, during which time they will be depreciated toward a $36,000 salvage value using straight-line depreciation. The rigs are expected to have a market value in 5 years equal to their salvage value. The new tractors will be used to replace the company's older fleet of eight trucks which are fully depreciated but can be sold for an estimated $17,000 (because the tractors have a current book value of zero, the selling price is fully taxable at the firm's 27 percent tax rate). The existing tractor fleet is expected to be useable for 5 more years after which time they will have no salvage value. The existing fleet of tractors uses $205,000 per year in diesel fuel, whereas the new, more efficient fleet will use only $160,000. In addition, the new fleet will be covered under warranty, so the maintenance costs per year are expected to be only $11,000 compared to $34,000 for the existing fleet. a. What are the differential operating cash flow savings per year during years 1 through 5 for the new fleet? b. What is the initial cash outlay required to replace the existing fleet with the newer tractors? c. What does the timeline for the replacement project cash flows for years 0 through 5 look like? d. If Madrano requires a discount rate of 7 percent for new investments, should the fleet be replaced? a. The differential operating cash flow savings per year during years 1 through 4 for the new fleet are S. (Round to the nearest dollar.)

Explanation / Answer

Year

savings in fuel

45000

savings in mainetenance cost

23000

total savings

68000

less annual depreciation =(440000-36000)/5

80800

before tax savings

-12800

less taxes-27%

-3456

after tax savings

-9344

add depreciation

80800

operatng cash flow

71456

recovery of scrap value

36000

net operating cash flow

71456

107456

cash outlay

costs of truck

-440000

less after tax sale proceeds of old truck =(17000*(1-.27))

10710

net cash outlay

-429290

Time line for project cash flow

Year

net operating cash flow

-429290

71456

107456

Time line for project cash flow

Year

net operating cash flow

-429290

71456

107456

present value of cash flow = cash flow/(1+r)^ n r= 7%

-429290

66781.31

62412.44

58329.38

54513.44

76614.64

NPV = sum of present value of cash flow

-110639

No it should not be replaced as it results in negative NPV

Year

savings in fuel

45000

savings in mainetenance cost

23000

total savings

68000

less annual depreciation =(440000-36000)/5

80800

before tax savings

-12800

less taxes-27%

-3456

after tax savings

-9344

add depreciation

80800

operatng cash flow

71456

recovery of scrap value

36000

net operating cash flow

71456

107456

cash outlay

costs of truck

-440000

less after tax sale proceeds of old truck =(17000*(1-.27))

10710

net cash outlay

-429290

Time line for project cash flow

Year

net operating cash flow

-429290

71456

107456

Time line for project cash flow

Year

net operating cash flow

-429290

71456

107456

present value of cash flow = cash flow/(1+r)^ n r= 7%

-429290

66781.31

62412.44

58329.38

54513.44

76614.64

NPV = sum of present value of cash flow

-110639

No it should not be replaced as it results in negative NPV

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(Related to Checkpoint 12.2) (Replacement project cash flows) Madrano\'s Wholesa

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