XYZ Company is considering the purchase of a new delivery truck. The truck will

Question

XYZ Company is considering the purchase of a new delivery truck. The truck will cost $40,000 and have useful life of 5 years with a salvage value of S0. The new truck is muc more efficient than the old delivery truck and should save the company annual cash oper expenses of S 12,000. Straight-line depreciation will be used. The income tax rate is 25% XYZ Company's hurdle rate is 10%. PRESENT VALUE TABLES ON PAGE 12. 4. Payback is equal to A. 3.44 ycars B. 3.54 years C. 3.64 years D. 3.74 years 5· The Accounting Rate of Return (ARCR) is equal to A. 10.5% B. 9.5% C. 8.5% D. 7.5% 6. The Net Present Value (NPV) is equal to A. $1,701 B. $1,801 C. $1,901 D. $2,001 7. The Profitability Index (Pl) is equal to A. 94 B. 1.04 C. 1.14 D. 1.24 8. The Internal Rate of Return (IRR) is equal to A· 9.7% B. 10.7% D. 12.7%

Explanation / Answer

Calculating the annual cash flows:

* Depreciation per annum = (Initial Investment Scrap Value) ÷ Useful Life in Years = $(40,000-0)/5 = $8000, tax saving on depreciation per annum = $8000*0.25 = $2000

Ans 4. C, 3.64 years

Payback Period = A +(B/C), where:

Step 1: Prepare the cumulative cash flow table:

Step 2: Calculate Payback period

Payback Period = 3 + (7000/11000) = 3.64 years

Ans 5: D. 7.50%

Average Accounting Profit = Annual Cost savings due to project - Annual Depreciation - Tax expense = (12000-8000) - (25% of 12000-8000) = $3000

Initial Investment = $40,000

AROR = (3000/40000)*100 = 7.50%

Ans 6: A. $1701

PVF is calculated by using following formula PVF for year n = 1/(1+Required Rate of Return)n )

NPV = Total of PVs calculated above = $1701

Ans 7: B. 1.04

PI = (NPV+Initial Investment)/ Initial Investment

= (1701+40000) / 40000 = 1.04

Ans 8: C. 11.7% , Calculated as below:

Step 1: calculate NPV using two discount rates (I have taken 10% and 15%)

NPV @ 10% already caculated = $1701

NPV @ 15%:

Step 2: Calculate IRR using following formula:

IRR = Rate 1 + [ (NPV at Rate 1 x (rate 2 - rate 1) ) / (NPV at rate 1 - NPV at rate 2)]

= 0.10+[(1701*(.15-.10))/(1701 - (-3124))]

= 11.7%

Year 0 1 2 3 4 5 Initial Investment (40,000) 0 0 0 0 0 Savings in operating expenses (net of tax @25%) 0 9,000 9,000 9,000 9,000 9,000 Annual Tax savings on depreciation* 0 2,000 2,000 2,000 2,000 2,000 Total Cash Flows (40,000) 11,000 11,000 11,000 11,000 11,000

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