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 that is more efficient. The old van cost $40,000 when it was purchased 5 years ago. The old van is being depreciated using the simplified straight-line method over a useful life of 8 years. The old van could be sold today for $7,000. The new van has an invoice price of $80,000, and it will cost $6,000 to modify the van to carry the company's products. Cost savings from use of the new van are expected to be $28,000 per year for 5 years, at which time the van will be sold for its estimated salvage value of $18,000. 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 $5,000 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) $18,875

B) $19,985

C) $22,305

D) $24,220

Explanation / Answer

Depreciation new machine (80000+6000)/5= 86000/5 =17200

Depreciation old machine =40000/8 =5000

Cost savings from use of the new van 28000 Depreciation 17200-5000 12200 Net saving 15800 Tax 35% 5530 After tax 10270 Add depreciation 12200 incremental free cash flow 22470

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