(Calculating replacement project cash flows) The Louisiana Land and Cattle Company

(LL&CC) is one of the largest cattle buyers in the country. It has buyers at all the major cattle auctions throughout the U.S. Southeast who buy on the company’s behalf and then have the cattle shipped to Sulpher Springs, Louisiana, where they are sorted by weight and type before shipping off to feedlots in the Midwest. The company has been considering the replacement of its tractor-trailer rigs with a newer, more fuel-efficient fleet for some time, and a local Peterbilt dealer has approached the company with a proposal. The proposal calls for the purchase of 10 new rigs at a cost of $100,000 each. Each rig will be depreciated toward a salvage value of

$40,000 over a period of five years. If LL&CC purchases the rigs, it will sell its existing fleet of 10 rigs to the Peterbilt dealer for the current book value of $25,000 per unit. The existing fleet will be fully depreciated in one more year but is expected to be serviceable for five more years, at which time each rig will be worth only $5,000 per unit as scrap. The new fleet of trucks is much more fuel-efficient and will require only $200,000 for fuel costs compared to $300,000 for the existing fleet. In addition, the new fleet of trucks will require minimal maintenance over the next five years, equal to an estimated $150,000 compared to the almost $400,000 that is currently being spent to keep the older fleet running.

a. What are the differential operating cash flow savings per year during Years 1 through 5 for the new fleet? The firm pays taxes at a 30 percent marginal tax rate.

b. What is the initial cash outlay required to replace the existing fleet with new rigs?

c. Sketch a timeline for the replacement project cash flows for Years 0 through 5.

d. If LL&CC requires a 15 percent discount rate for new investments, should the fleet be replaced?