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ABANDONMENT OPTION The Scampini 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 $6,250 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 10%. Year Annual After-Tax Cash Flow Abandonment value 0 ($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; 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...

14th Edition
Eugene F. Brigham + 1 other
Publisher: Cengage Learning
ISBN: 9781285867977
BuyFind

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
Publisher: Cengage Learning
ISBN: 9781285867977

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Chapter
Section
Chapter 13, Problem 4P
Textbook Problem

ABANDONMENT OPTION The Scampini 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 $6,250 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 10%.

Year Annual After-Tax Cash Flow Abandonment value
0 ($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
  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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