(Replacement project cash? flows) ?Madrano\'s Wholesale Fruit Company located in
ID: 1172707 • Letter: #
Question
(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 ?$380,000 on eight rigs. The new trucks will be kept for 5 years, during which time they will be depreciated toward a ?$43,000 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 29 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 ?$215,000 per year in diesel? fuel, whereas the? new, more efficient fleet will use only ?$100,000.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 ?$32,000 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 8 percent for new? investments, should the fleet be? replaced?
Explanation / Answer
a.Operating Cash Flows per Year for the existing fleet:
Fuel net of tax= 215,000(1-.29) = 152,650
Maintenance Costs net of tax= 32,000(1-.29) = 22,720
Total Cost per year net of tax= 247,000(1-.29) = 175,370
New Fleet:
Fuel = 100,000(1-.29) = 71,000
Maintenance Cost = 11,000 (1-.29) = 7810
Tax Saving on Depreciation = 67400*29% = (19546)
Total Cost net of tax = 59,264
Differential operating cash flow savings per year for New Fleet = 175,370 – 59,264 = $116,106
Working Note:
Depreciation = (380,000-43000)/5 = 67,400
All costs have been taken net of sax since tax will be saved on all costs incurred
b. Initial Cash Outlay Required = Cost of New Fleet – Salvage Value of Old net of Tax
=380,000-17000(1-.29)
=$367,930
c. The timeline for the replacement project cash flows for years 0 through 5 looks? like recovery in the form of annuity as there will be equal amount of savings in Cash Flows each year
d. NPV = Present Value of Cash Inflows – Present Value of Cash Outflows
= 116,106*PVAF(8%, 5 years) + 43,000*PVF(8%, 5years) – 367930
=116,106*3.99 + 43,000*0.681 – 367,930
=124,616
The fleet should be replaced, as it provides higher return than required 8%
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