You have been asked by the president of your company to evaluate the proposed ac

Question

You have been asked by the president of your company to evaluate the proposed acquisition of a new special purpose truck. You hire a consultant to make a recommendation. The consultant charges you $1500 and recommends a CP8 truck. The truck's price is $40,000 and it will cost another $10,000 to modify it for special use by your firm. The company expects to sell this new truck in three years for $20,000 (salvage value), Use of the truck will require an increase in the company's net working capital of $2,000. Use of the truck is expected to increase the firm's EBIT by $25,000. The firm's marginal tax rate is 40%. What is: a. the initial outlay required to fund this project? b. the annual after tax cash flows for the new truck project? c. the terminal cash flow for the new truck project?

Explanation / Answer

a) Initial outlay = 1500 + 40000 + 10000 + 2000 = $ 53,500

b) depreciation per year = $ 20,000/3

EBIT = $25,000

EBIT - depreciation = 25,000-20,000/3 = $ 18,333.3

tax = .4*18,333.3 = 7,333.33

EBIT - tax = 25,000-7,333.33

after tax cash flow = $ 17,666.67

cash flow = -53,500 + 17,666.67 + 17,666.67 + 17,666.67 + 20,000

Terminal cash flow = $20,000

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