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QUESTION 4. [18 + 2 = 20 marks].
This question relates to capital budgeting.
Interstate Haulage Ltd is considering the purchase of two new modern large trucks costing $500,000 each, which it will fully finance with a fixed interest loan of 8% per annum, with interest paid monthly and the principal repaid at the end of 4 years. The trucks will be used in the company's interstate and intra-state trucking business.
The two new trucks will replace three existing smaller trucks and will permit the company to reduce its storage costs by $50,000 a year and its labour costs by $200,000 a year,
both over the next 4 years. [Assume these savings are realized at the end of each year.]
The new trucks may be depreciated for tax purposes by the straight-line method to zero over the next 4 years. The company thinks that it can sell the trucks at the end of 4 years for $150,000 each.
10
QUESTION 4 continued.
The three smaller old trucks were bought 3 years ago for $300,000 each, with a then life expectancy of 5 years, and have been depreciated by the straight-line method at 20% a year. If the company proceeds with the above purchase, the old trucks will be sold this month for $100,000 each.
This is not the first time that the company has considered this purchase and replacement. Twelve months ago, the company engaged Cartage Consultants, at a fee of $20,000 paid in advance, to conduct a feasibility study on savings strategies and Cartage made the above recommendations. At the time, Interstate Haulage Ltd did not proceed with the recommended strategy, but is now reconsidering the proposal.
Interstate Haulage Ltd further estimates that it will have to spend tax-deductible amounts of $40,000 in 2 years' time and $50,000 in 3 years' time overhauling the trucks.
It will also require additions to current assets of $30,000 at the beginning of the project, which will be fully recoverable at the end of the fourth year.
lnetaerrsitnawtehli-lcah eulaagmeinLgtds are received.
coeficvaepdi.tal is 10%. The tax rate is 30%. Tax is paid in the
y
REQUIRED:
(a) Calculate the net present value (NPV), that is, the net benefit or net loss in present value terms of the proposed purchase costs and the resultant incremental cash flows.
[HINT: As shown in the text-book, it is recommended that for each year you calculate the tax effect first, then identify the cash flows, then calculate the overall net present value. Finally, make your recommendation.]
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AAA - FIN700 -...rial, May, 2018 - Read-only