Question

QUESTION 19

1. Consider the following set of net cash flows and the annual salvage values for a new delivery truck purchased by ABC Transportation Company. Cost of capital is 10%. What is the project's optimal economic life?

   Year	NCF	Salvage
   		Value
   0	-22,500	22,500
   1	7,000	18,000
   2	7,000	14,800
   3	7,000	11,000
   4	7,000	8,000
   5	7,000	0

   		2 years
   		3 years
   		4 years
   		5 years

Answer 1

The optimal economic life of the project is the one that produces the highest NPV.

2 years NPV

NPV = -22,500 + 7,000/1.1 + (7,000 + 18,000)/1.1^2

NPV = $4,524.8

3 years NPV

NPV = -22,500 + 7,000/1.1 + 7,000/1.1^2 + (7,000 + 11,000)/1.1^3

NPV = $3,172.42

4 years NPV

NPV = -22,500 + 7,000/1.1 + 7,000/1.1^2 + 7,000/1.1^3 + (7,000 + 8,000)/1.1^4

NPV = $5,153.16

5 years NPV

NPV = -22,500 + 7,000/1.1 + 7,000/1.1^2 + 7,000/1.1^3 + 7,000/1.1^4 + 7,000/1.1^5

NPV = $4,035.5

The optimal economic life of the project is 4 years since this produces the highest NPV.