Textbook Problem

ABANDONMENT OPTION The Sorensen Supplies Company recently purchased a new delivery truck. The new truck costs $22,500; and it is expected to generate after-tax cash flows, including depreciation, of $5,875 per year. The truck has a 5-year expected life. The expected year-end abandonment values (salvage values after tax adjustments) for the truck are given here. The company's WACC is 9%.

Year	Annual After-Tax Cash Flow	Abandonment Value
1	($22,500	—
2	5,875	$17,000
3	5,875	15,000
4	5,875	9,000
5	5,875	4,750
6	5,875	0

1. a. Should the firm operate the truck until the end of its 5-year physical life; if not, what is the truck's optimal economic life?
2. b. Would the introduction of abandonment values, in addition to operating cash flows, ever reduce the expected NPV and/or IRR of a project? Explain.