Question

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%.

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

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-YesNo

Answer 1

a.

Decrease in value of Truck in year 1 is $5,500 ($22,500 - $17,000) and benefit earn is $5,875. So truck must operate in one year. In second year Decrease in value of Truck is $2,000 ($17,000 - $15,000) and benefit earn is $5,875. So truck must operate in second year.

Decrease in value of Truck in year 3 is $6,000 ($15,000 - $9,000) asd benefit earn is $5,875. in year 3 benefit earn is less than decrease in value of truck. So economic life of truck is 2 year.

b.

An introduction of abandonment values, in addition to operating cash flows, might reduce the economic life of an assets, so IRR or NPV of project will reduced from actaul NPV or IRR.

So, yes NPV or IRR might reduce.