Capital Budgeting Problem

You have been asked by the president of your company to evaluate the proposed acquisition of a new special-purpose truck. The truck's basic price is $50,000, and it will cost another $10,000 to modify it for special use by your firm. The truck falls into the MACRS three-year class, with depreciation rates of 33 percent, 45 percent, 15 percent, and 7%, and it will be sold after three years for $20,000. Use of the truck will require an immediate increase in net operating working capital (spare parts inventory) of $2,000. The truck would increase the firm's before-tax revenues by $25,000 per year but would also increase operating costs (excluding depreciation) by $5,000 per year. The firm's marginal tax rate is 40 percent and the relevant cost of capital is 10%. Assume that the company has other profitable projects so that any operating losses on this project will be used to offset taxable operating income on other projects.

You must develop a full solution (in spreadsheet format) to this problem before answering the questions.

A) What is the net investment in the truck at t = 0?

B) What are the net operating cash flows?

• What is the terminal (salvage, non-operating) cash flow at the end of Year 3?
• What is the Payback for this investment?
• What is the NPV of this investment?
• What is the IRR of this investment?
• Should this investment be undertaken? Why?