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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 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? 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.

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Fundamentals of Financial Manageme...

9th Edition
Eugene F. Brigham + 1 other
Publisher: Cengage Learning
ISBN: 9781305635937
BuyFind

Fundamentals of Financial Manageme...

9th Edition
Eugene F. Brigham + 1 other
Publisher: Cengage Learning
ISBN: 9781305635937

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Chapter
Section
Chapter 12, Problem 17P
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.

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