your company is considering the replacement of an old delivery van with a new on

Question

your company is considering the replacement of an old delivery van with a new one one that is more efficient. The old van cost $40000 when it purchased 5 years ago. The old van is being depreciated using the simplified straight- line method over a useful life of 8 years. The old van could be sold for $7000. The new van has an invoice price of $80000, it will cost $6000 to carry the company's product. Cost savings from the use of the new van are expected to be $28000 per for 5 years. At which the new van will be sold for its estimated salvage value of $18000. The new van will be depreciated using the straight-line method over its 5- useful life years. The company's tax rate is 35%. The working capital is expected to increase by $5000, at the inception of the project, but this amount will be recaptured a the end of year 5. What is the initial outlay required to fund this replacement project? What is the terminal cash flow?

Explanation / Answer

Old van cost= $40000 Cost of new van=80000 Working capital requirement= 5000 Life of old van = 8 years Salvage value= 18000 Already depreciated for 5 years life= 5 years Tax rate= 35% Sale proceeds of old van = 7000 Deprecation per annum = 40000/8=5000 cash out flow on purchase of new van= 80000-7000+2800=75800 Cash outflow on increase in working capital= 5000 Book value of old van= 40000-(5000*5)= 15000 total initial cash outflow=75800+5000=80800 Sale price= 7000 Capital loss= 15000-7000= 8000 Tax saving on capital loss= 8000*35%=2800 (inflow) Terminal cash flow refers to cash inflow at the end of the project Salvage value = 18000 Working capital= 5000 Total terminal cash flow= 23000

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