Capital Budgeting

Integrated Practice Problem

Armando is considering a new truck for his pizza delivery business. The truck will allow him to service a

new part of the town where he is located. Assume Armando will use the truck for three years. At that

time he will enter an MBA program and sell his business. He hires you to analyze the purchase and you

have collected the following data to aid your analysis:

The truck costs $$25,000$ and will be straight$-$line depreciated to zero over $5$ years

Armando's pizza business currently generates $$100,000$ of revenue each year. The truck will

generate incremental annual pre$-$tax revenue of $$33,000$ each year for three years, with the first

incremental revenue occurring one year from now.

Variable costs $($cost of goods sold and operating expenses$)$ for Armando's business are $60\%$ of

revenue.

Maintenance expenses associated with the new truck are estimated at $$1000$ for Years $1-3$

Interest expense on a bank loan for the truck will be $$1,500$ annually in Years $1-3$

Armando recently paid a vehicle broker $$250$ cash to help him find the best deal on the new

truck

Armando has garage space to store the new truck. If he doesn't buy the new truck, he will rent

the space to a nearby repair business for $$100$ per month $($before tax$)$ in Years $1-3.$

Armando will have additional Inventory and Accounts Payable $($A$/$P$)$ due to the new truck. The

Inventory balance will rise by $$2,310$ and the A$/$P balances will rise by $$990.$ Both changes will

occur right away.

The tax rate is $40\%$ and the cost of capital is $12\%$

At the end of three years, Armando plans to sell the truck for $$8,000$

Calculate the relevant cash flows for the new truck project and compute the NPV$,$ IRR, and Payback

Period. What is your recommendation?