Question

Economic Life

The Scampini Supplies Company recently purchased a new delivery truck. The new truck cost $22,500, and it is expected to generate net after-tax operating cash flows, including depreciation, of $6,250 per year. The truck has a 5-year expected life. The expected salvage values after tax adjustments for the truck are given below. The company's cost of capital is 11 percent.

Year	Annual Operating Cash Flow		Salvage Value
0	-$22,500		$22,500
1	6,250		17,500
2	6,250		14,000
3	6,250		11,000
4	6,250		5,000
5	6,250		0

1. What is the optimal number of years to operate the truck?

Answer 1

		Present Value (PV) of Cash Flow:
		(Cash Flow)/((1+i)^N)
		i=Discount Rate=Cost of Capital=11%
		N=Year of Cash Flow
			N	A	B=A/(1.11^N)	C=-(22500-B)	D	E=D/(1.1^N)	F	G=C+F	H(Using PMT function with Rate=11%,Nper=N,PV=-G)
			End of year	Salvage Value	PV of Salvage Value	PV of net capital cost	Annual Operating Cash Flow	PV of annual Cash Flow	Cumulative PV of annual Cashflow	PV of total Cash Flow	Equivalent annualcost
			0
			1	$17,500	$15,766	($6,734)	$6,250	$         5,682	$        5,682	($1,052)	($1,168)	(Using PMT function with Rate=11%,Nper=1,PV=-1052)
			2	$14,000	$11,363	($11,137)	$6,250	$         5,165	$     10,847	($290)	($169)	(Using PMT function with Rate=11%,Nper=2,PV=290)
			3	$11,000	$8,043	($14,457)	$6,250	$         4,696	$     15,543	$1,086	$444	(Using PMT function with Rate=11%,Nper=3,PV=-G1086)
			4	$5,000	$3,294	($19,206)	$6,250	$         4,269	$     19,812	$605	$195	(Using PMT function with Rate=11%,Nper=4,PV=-605)
			5	$0	$0	($22,500)	$6,250	$         3,881	$     23,692	$1,192	$323	(Using PMT function with Rate=11%,Nper=4,PV=-1192)
		Annual EquivalentCash Flow is HIGHEST for 3 years		$444
		The Truck should be operated for OPTIMUM 3 years
					Editing Number Clipboard Font Alignment Styles Cells =PMT(11 %, G12,-N12) fix O12 G H K L M N Present Value (PV) of Cash Flow: (Cash Flow)/((1+i)^N) i=Discount Rate=Cost of Capital=11% 4 N=Year of Cash Flow 5 6 E D/(1.1^N) F B=A/(1.11 N C=-(22500-B) D H(Using PM 7 N G C+F Annual Cumulativ PV of PV of Operatin PV of e PV of total Salvage Salvage PV of net g Cash annual Cash annual Cash Equivalent Cashflow End of year Value Value Flow Flow annualcost capital cost Flow 9 0 ($6,734) $6,250 $ ($11,137) ($14,457) ($1,168) ($169) $444 $17,500 $15,766 5,682$ 5,165 10,847 5,682 ($1,052) ($290) $1,086 10 $14,000 $11,363 $6,250 $ 11 2 $11,000 $8,043 $6,250 $ 4,696 15,543 12 33