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Capital Budgeting

Holmes Corporation recently purchased a new delivery truck. The new truck costs $25,000 and is expected to generate net after-tax operating cash flows, including depreciation, of $7,000 at the end of each year. The truck has a 5-year expected life. The expected abandonment values (salvage values after tax adjustments) at different points in time are given below. (Note that these abandonment value estimates assume that the truck is sold after receiving the project's cash flow for the year.) The firm's cost of capital is 10 percent.
Year Abandonment value
1 $20,000
2 15,000
3 10,000
4 5,000
5 0

At what point in time would the company choose to sell (abandon) the truck in order to maximize its NPV?

A.After one year

B.After two years

C.After three years

D.After four years

E.It would never choose to sell the truck.

Solution Preview

In order to solve this we need to calculate the NPV for each year. In each year we earn $7,000 and the salvage value of the truck. We get the following table ...

Solution Summary

The solution explains how calculate when an asset should be abandoned given the salvage value in different years so as to maximize the NPV of the project