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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