Question

Ajax Rentals has an opportunity to purchase a truck for $130000 with a useful life of 5 years and with a $20000 salvage value. Spare parts totaling $4000 must be purchased when the truck is acquired and this cost will be recovered at the end of the truck's useful life. After two years a $25000 major overhaul is needed. Ajax can generate $75000 a year in delivery revenues, and operating expenses will be $35000 a year, without depreciation. Cost of capital is 8%.

What is the present value of cash outflows? Assuming Ajax has a 40% tax rate, would it accept the project?

Answer 1

Annual revenue			75000
Less: Annual O&M expense			35000
Net annual savings			40000
Less: Dep (130000-20000)/5			22000
Net income before tax			18000
Less: Tax @ 40%			7200
Net income after tax			10800
Add: Depreciation			22000
Annual cash inflows			32800
Annuity PVF at 8% fr 5 years			3.9927
Present value of inflows			130960.6
Add: Present value of salvage and Spare parts			16334.4
(20000+4000)*0.6806
Present value of total inflows			147295
Less: Initial investment			130000
Less: Spare parts purchased			4000
Less: Present value of overhauling			21432.5
(25000*0.8573)
Net present value			-8137.54