A company is considering the replacement of an old delivery van with a new one t

Question

A company is considering the replacement of an old delivery van with a new one that is more efficient. The old van cost $30,000 when it was purchased 5 years ago. The old van is being depreciated using the simplified straight-line method over a useful life of 10 years. The old van could be sold today for $5,000. The new van has an invoice price of $75,000, and it will cost $5,000 to modify the van to carry the company's products. Cost savings from the use of the new van are expected to be $22,000 per year for 5 years, at which time the van will be sold for its estimated salvage value of $15,000. 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 $3,000 at the inception of the project, but this amount will be recaptured at the end of year five. What is the incremental free cash flow of year one?

Explanation / Answer

Here we have the outlay of two things going on: first, we sell our old van, then buy our new one (along with all the working capital that goes with it.) Selling the old van is equal to: salvage = 5000, book value = 15,000 and tax rate is 35%. I answered how to get the book value of the van in a similar problem. so the value of this is = Salvage - (Salvage - Book Value)*(t) = 5000 - (5000 - 15000)*(0.35) = 8500 The van costs 75,000 to buy and an additional 5000 to modify to use so we have 80,000 for the cost of the van. We must also increase working capital by 3000 (maybe buy some inventory) to make the project work. So our cash outflow from the van was -83,000. We gained 8500 from selling the old van so our initial outlay = $8500 - $83000 = -$74,500

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.