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.