The company is considering expanding its current operations by adding new trucks to its fleet. Based on the firm’s forecasts, its current fleet is inadequate to meet demand. The company expects to increase revenues with this asset expansion project. The firm depreciates the trucks over a 6-year economic lifetime, using the declining balanced method, and will sell the trucks after 6 years. The firm’s marginal tax rate is 34 percent. Depreciation must be calculated according to the declining balance method, using an annual depreciation percentage of 20%.

The company pay (or receive) tax on the difference between the book value and the market value of the trucks when they sell them in year 6.

Formula hint: Tax on salvage value = (book value – market value) * tax rate.

The following are estimates of the project’s incremental cash flows:

• Purchase price of the truck is $495,000

• Delivery costs of the truck is $5,000

• Revenues of $300,000 in year 1, $350,000 in years 2 and 3, and $375,000 in years 4 to 6 (incl.)

• Operating expenses (excluding depreciation) is 40 percent of revenue

• Salvage value of the trucks is $100,000 in year 6

Required

1. Given these estimates, what are the initial investment, operating cash flows, and the terminal cash flow for Company?
2. Consider a discount rate of 10%, would you advise the company to invest in the new trucks? Perform the relevant calculations in order to answer this question.
3. How will your calculations and answers for assignment 1) and 2) change if the trucks are sold for the remaining book value in year 6, instead of salvage value of $100,000?
4. What would the answer to question 2 be, if the actual revenues proved to be 40% above the expected level, and the investment (trucks) furthermore would have salvage value of $0?

Answer rating: 100% (QA)

Initial Investment The initial investment includes the purchase price of the truck delivery costs and any initial setup costs Initial Investment Purch... View the full answer