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Capital Budgeting Problem
You have been asked by the president of your company to evaluate the proposed acquisition of a new special-purpose truck. The truck’s basic price is $50,000, and it will cost another $10,000 to modify it for special use by your firm. The truck falls into the MACRS three-year class, with depreciation rates of 33 percent, 45 percent, 15 percent, and 7%, and it will be sold after three years for $20,000. Use of the truck will require an immediate increase in net operating working capital (spare parts inventory) of $2,000. The truck would increase the firm’s before-tax revenues by $25,000 per year but would also increase operating costs (excluding depreciation) by $5,000 per year. The firm’s marginal tax rate is 40 percent and the relevant cost of capital is 10%. Assume that the company has other profitable projects so that any operating losses on this project will be used to offset taxable operating income on other projects.
You must develop a full solution (in spreadsheet format) to this problem before answering the questions.
A) What is the net investment in the truck at t = 0?
B) What are the net operating cash flows?
C) What is the terminal (salvage, non-operating) cash flow at the end of Year 3?
D) What is the Payback for this investment?
E) What is the NPV of this investment?
F) What is the IRR of this investment?
G) Should this investment be undertaken? Why”
You have been asked by the President of your company to evaluate the proposed acquisition of anew special purpose truck with the following additional facts:-The truck’s basic price is $50,000,…
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