Response to the following problem:
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 10 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
|
a. Should the firm operate the truck until the end of its 5-year physical life, or, if not, what is its optimal economic life?
b. Would the introduction of salvage values, in addition to operating cash flows, ever reduce the expected NPV and/or IRR of a project?