Capital Budgeting Risk Analysis
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 10%.
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?
This solution finds the optimal economic life in this case.