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    Capital Budgeting Risk Analysis

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    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?

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    Solution Summary

    This solution finds the optimal economic life in this case.