You have been asked to evelatute (cost justify) the aquistion of a new truck for

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You have been asked to evelatute (cost justify) the aquistion of a new truck for use in your company. The truck will cost $100,000 and will require $20,000 of modifications to make it ready for use. The truck has a 5 year useful life and yoru company uses MACRS for depreciation. You anticipate using the truck for 2 years and then selling it for $65,000. During the 2 years of operations, you project revenues of $75,000 and operating expenses of $25,000. Your target weights are 50% for long term debt and 50% for common equity (no short term debt or preferred stock are used by the business. Your anticipated gross rate on long term debt is 9.00%. Your firm's most recent annual dividend was $8,500,000 and the Total Common Equity is $50,000,000. Your company income tax rate is 40%. Base on the above... (1) What is the Capital Investment? (2) What is the Accumulated Depreciation After Two Years (3) What is the Salvage Value of the Truck? (4) What are the Year 1 and 2 Operating Cash Flows? (5) What is the Weighted Average Cost of Capital? (6) What is the NPV of the Project (discounted at the WACC)? You have been asked to evelatute (cost justify) the aquistion of a new truck for use in your company. The truck will cost $100,000 and will require $20,000 of modifications to make it ready for use. The truck has a 5 year useful life and yoru company uses MACRS for depreciation. You anticipate using the truck for 2 years and then selling it for $65,000. During the 2 years of operations, you project revenues of $75,000 and operating expenses of $25,000. Your target weights are 50% for long term debt and 50% for common equity (no short term debt or preferred stock are used by the business. Your anticipated gross rate on long term debt is 9.00%. Your firm's most recent annual dividend was $8,500,000 and the Total Common Equity is $50,000,000. Your company income tax rate is 40%. Base on the above... (1) What is the Capital Investment? (2) What is the Accumulated Depreciation After Two Years (3) What is the Salvage Value of the Truck? (4) What are the Year 1 and 2 Operating Cash Flows? (5) What is the Weighted Average Cost of Capital? (6) What is the NPV of the Project (discounted at the WACC)?

Explanation / Answer

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(1) What is the Capital Investment? 120000 (2) What is the Accumulated Depreciation After Two Years 120000-65000/5= 11000 22000 (3) What is the Salvage Value of the Truck? 65000 (4) What are the Year 1 and 2 Operating Cash Flows? Particulars Yr1 Yr 2 projected revanues 75000 75000 projected expenses 25000 25000 less: Depreciation 11000 11000 operating profit before tax 39000 39000 Less: Tax @40% 15600 15600 Post tax operating profits 23400 23400 Add: Depreciation 11000 11000 CFAT 34400 34400 Add: Post tax Salvage value 0 78200 Book Value of truck=120000-(11000 x 2)= 98000 Salvage value 65000 Loss 33000 Tax savings=33000*40% 13200 Post tax salvage value=13200+65000 78200 34400 112600 (5) What is the Weighted Average Cost of Capital? cost of equity=8500000/50000000*100 17.00% cost of debt=9%x0.40 5.40% wacc=17*0.5+9*0.5= 11.20% (6) What is the NPV of the Project (discounted at the WACC)? Yr Cash Flows PV Factors@11.20% Present Value 0 -120000 1.0000 -120000 1 34400 0.8993 30935.25 2 112600 0.8087 91060.25 NPV 1995.497

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