ABC Construction must replace a number of its concrete mixer trucks with new tru
ID: 2769708 • Letter: A
Question
ABC Construction must replace a number of its concrete mixer trucks with new trucks. It has received two bids and has evaluated closely the performance characteristics of the various trucks. The truck A, which costs $70,000, is top-of-the-line equipment. The truck has a life of eight years, assuming that the engine is rebuilt in the fifth year. Maintenance costs of $3,000 a year are expected in the first four years, followed by total maintenance and rebuilding costs of $12,000 in the fifth year. During the last three years, maintenance costs are expected to be $4,000 a year. At the end of eight years the truck will have an estimated scrap value of $10,000.
The trucks B cost $55,000 a truck. Maintenance costs for the truck will be higher. In the first year they are expected to be $4,000, and this amount is expected to increase by $1,500 a year through the eighth year. In the fourth year the engine will need to be rebuilt, and this will cost the company $18,000 in addition to maintenance costs in that year. At the end of eight years the truck will have an estimated scrap value of $7,000.
a) Using MACRS (5-year property), estimate the after-tax cash flows related to the trucks? (Use Tax rate of 35%)
b) If ABC Construction’s opportunity cost of funds is 10%, which truck should it accept?
c) If its opportunity cost were 15%, would your answer change?
Explanation / Answer
Truck A Details Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 MACRS Rate 20.0% 32.0% 19.2% 11.52% 11.52% 5.76% Investment 70,000 Maintenance costs 3,000 3,000 3,000 3,000 12,000 4,000 4,000 4,000 Scrap Value (10,000) Depreciation Tax shield=Depreciation*Tax rate35% (4,900) (7,840) (4,704) (2,822) (2,822) (1,411) - - a Net Cash flows -After Tax 70,000 (1,900) (4,840) (1,704) 178 9,178 2,589 4,000 (6,000) PV factor @10% 1 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467 PV of Cash Flows 70,000 (1,727) (4,000) (1,280) 121 5,699 1,461 2,053 (2,799) Net PV of Cash flows(costs) $ 69,527.26 Truck B Details Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 MACRS Rate 20.0% 32.0% 19.2% 11.52% 11.52% 5.76% Investment 55,000 Maintenance costs 4,000 5,500 7,000 8,500 10,000 11,500 13,000 14,500 Rngine rebuild cost 18,000 Scrap Value (7,000) Depreciation Tax shield=Depreciation*Tax rate35% (3,850) (6,160) (3,696) (2,218) (2,218) (1,109) - - a Net Cash flows -After Tax 55,000 150 (660) 3,304 24,282 7,782 10,391 13,000 7,500 PV factor @10% 1 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467 PV of Cash Flows 55,000 136 (545) 2,482 16,585 4,832 5,866 6,671 3,499 Net PV of Cash flows(costs) $ 94,526.14 b So Net PV of costs is less in Truck A, so Truck A may be purchased. c When Discount Rate is 15%: Truck A Details Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 MACRS Rate 20.0% 32.0% 19.2% 11.52% 11.52% 5.76% Investment 70,000 Maintenance costs 3,000 3,000 3,000 3,000 12,000 4,000 4,000 4,000 Scrap Value (10,000) Depreciation Tax shield=Depreciation*Tax rate35% (4,900) (7,840) (4,704) (2,822) (2,822) (1,411) - - Net Cash flows -After Tax 70,000 (1,900) (4,840) (1,704) 178 9,178 2,589 4,000 (6,000) PV factor @15% 1 0.870 0.756 0.658 0.572 0.497 0.432 0.376 0.327 PV of Cash Flows 70,000 (1,652) (3,660) (1,120) 102 4,563 1,119 1,504 (1,961) Net PV of Cash flows(costs) $ 68,893.66 Truck B Details Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 MACRS Rate 20.0% 32.0% 19.2% 11.52% 11.52% 5.76% Investment 55,000 Maintenance costs 4,000 5,500 7,000 8,500 10,000 11,500 13,000 14,500 Rngine rebuild cost 18,000 Scrap Value (7,000) Depreciation Tax shield=Depreciation*Tax rate35% (3,850) (6,160) (3,696) (2,218) (2,218) (1,109) - - Net Cash flows -After Tax 55,000 150 (660) 3,304 24,282 7,782 10,391 13,000 7,500 PV factor @15% 1 0.870 0.756 0.658 0.572 0.497 0.432 0.376 0.327 PV of Cash Flows 55,000 130 (499) 2,172 13,884 3,869 4,492 4,887 2,452 Net PV of Cash flows(costs) $ 86,387.93 So Net PV of costs is less in Truck A, so no change is decision.