Your company is considering a replacement of an old delivery van with a new one

Question

Your company is considering a 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 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 statutory 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 for year one?

a. 18,850
b. 19,900
c. 21,305
d. 22,250

Explanation / Answer

Cost of New Van = 75000 + cost of mdification 5000 = 80000 Per year Dep on new Van = Cot of van/Life of van = 80000/5 = 16000 pa First year CF will be as below :- Cost savings $22000 Less Dep $16000 -------------------- EBT $6000 Less Tax 35% 2100 ---------------------- EAT $3900 Add back dep $16000 ------------------------ Net CF $19,900 So Correct ans is (b) $19,900

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