Question
Charlie's Wholesale Fruit Company, located in McAllen, Texas, is considering the purchase of a new fleet of trucks to be used in the delivery of
Charlie's Wholesale Fruit Company, located in McAllen, Texas, is considering the purchase of a new fleet of trucks to be used in the delivery of fruits and vegetables grown in the Rio Grande Valley of Texas. If the company goes through with the purchase, it will spend $350,000 on eight rigs and $50,000 on the shipping
cost. The new trucks will be kept for five years, during which time they will be depreciated toward a $40,000 salvage value using straight-line depreciation. The rigs are expected to have a market value in five years equal to $30,000. The new trucks will be used to replace the company's older fleet of eight trucks, which are fully depreciated without any salvage value but can be sold for an estimated $20,000 today. The existing truck fleet is expected to be usable for five more years, after which time the rigs will have market value of $1,000. The existing fleet of trucks uses $250,000 per year in diesel fuel, whereas the new, more efficient fleet will use only $150,000. In addition, the new fleet will be covered under warranty, so the maintenance cost per year are expected to be only $10,000 compared to $35,000 for the existing fleet. Those changes in operating activities will have decrease the company's requirement on net operating working capital as much as $20,000. The company's current revenue is $800,000 and projected to grow at 10% per annum for the next five years. Cost of goods sold is always 50% of the company's revenue. A $50,000 annual fixed operating expense (excluding fleet related costs) will remain the same for the next five years. The company has none fixed assets except for the fleet. The company faces a marginal tax rate of 30%.
Question:
a. Calculate the replacement free cash flows generated by this proposed project!
b. If Charlie requires a 15% discount rate for the new investments, should the fleet be replaced? Use the NPV concept to answer this question!
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