ABANDONMENT OPTION The Sorensen Supplies Company recently purchased a new delive
ID: 2792552 • Letter: A
Question
ABANDONMENT OPTION
The Sorensen Supplies Company recently purchased a new delivery truck. The new truck costs $22,500, and it is expected to generate after-tax cash flows, including depreciation, of $5,875 per year. The truck has a 5-year expected life. The expected year-end abandonment values (salvage values after tax adjustments) for the truck are given below. The company's WACC is 9%.
a. What is the truck's optimal economic life?
year(s)
b. Would the introduction of abandonment values, in addition to operating cash flows, ever reduce the expected NPV and/or IRR of a project?
-Select-YesNoItem 2
Why? The input in the box below will not be graded, but may be reviewed and considered by your instructor.
Year Annual After-Tax
Cash Flow Abandonment
Value 0 ($22,500) - 1 5,875 $17,000 2 5,875 15,000 3 5,875 9,000 4 5,875 4,750 5 5,875 0
Explanation / Answer
a) If we calculate NPV for the value of the machines:
Y1 = 17000/ (1.09)^4 = $12043.2
Y2 = 15000 / 1.09^3= $11582.7
Y3 = 9000 / 1.09^2 = $7575
If we add first two years vakues, we get more than invested amount of $22,500. So the economic life is apx. 2 years
b) No, introduction of abandonment values doesnt change the NPV or IRR of this project. Because these values show the physical life of product which can be calcuated if we know the cashflows too. So providing these values will not make any any changes in NPV ot IRR of the project.