You are buying a new truck in order to grow your local moving service. The new t
ID: 2787286 • Letter: Y
Question
You are buying a new truck in order to grow your local moving service. The new truck costs $37,000. You will need to spend another $6,000 on hitches, ramps, and other special equipment for this use. You will use this truck for 4 years and then you plan that the salvage value will be $8,000.
The new truck should increase revenue by 40% over last year's $85,000 revenue. As a result of the truck purchase, operating expenses will increase by $11,000. The depreciation expense will increase by $2500. Your marginal tax rate is 35%.
In which year will salvage value affect the net cash flow calculations?
a) 3Explanation / Answer
Please note that we’ll need to consider the overall effect on the company and not the isolated effect of purchasing the truck. Therefore, Depreciation expense if considered only for new truck will be (43000 – 8000 )/4 =n 8750 but overall on the company’s books, it’ll increase by only 2500 dollars.
We have assumed that income due to the next truck will remain same for the 4 years and so will be the expenses. Income = 40% of 85000 = $34000.
Expense = $11000
Let’s get all this data neatly into a table.
As you can see from the above table, the salvage value affects the cash flow only in the terminal i.e 4th year. Thus the answer is b- 4
Year 0 Year 1 Year 2 Year 3 Year 4 Investment Outlay 43000 Income 34000 34000 34000 34000 Operating Expense 11000 11000 11000 11000 Depreciation 2500 2500 2500 2500 Operating Income before Taxes 20500 20500 20500 20500 Taxes(30%) 7175 7175 7175 7175 Operating Income after Taxes 13325 13325 13325 13325 Add back: Depreciation 2500 2500 2500 2500 After Tax Operating Cash Flow 15825 15825 15825 15825 Salvage Value 8000 Terminal Year After Tax Cash Flow 23825 Total After Tax cash flow 15825 15825 15825 23825Related Questions
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