NRW Holdings Limited (NRW) is a company listed on the Australian Securities Exchange (ASX). According to the following ASX announcement (hereafter, Announcement) made by NRW: 17/02/2022 9:35 am NRW Half Year Results Presentation the coal market is very strong. NRW is keen to take advantage of this strength and is investigating a proposal to replace one of their outdated inefficient mining trucks with a new CAT 793F truck. The new truck offers a larger carrying capacity and lower maintenance costs compared to the existing truck, and opens up more Load & haul contracting opportunities . Furthermore, as part of NRWs environmental initiatives, the new truck has a reduced fuel consumption. However, the cost of a new CAT 793F is $4.7 million and NRWs management accountant is concerned that the new trucks profitability wont justify the cost. Therefore, the accountant has approached the Chief Financial Officer (CFO) to express concerns. The CFO carefully and slowly explains the many reasons that profitability is not a good measure of financial success, and stresses that the appropriate action is to conduct a rigorous cost-benefit analysis to ensure that replacing the truck will add shareholder wealth.

2. Last month, NRW paid for a study by a civil engineering consultant at a cost of $75,000 and the study concluded that the large and growing infrastructure market will generate sufficient demand for a larger truck. Today, NRW must decide if they will proceed with the investment in the new truck, and the simultaneous sale of their existing truck.

3. If NRW purchase the new truck they must pay a third party to transport the truck to NRWs main mining facility at Boggabri at a cost of $26,000.

4. To operate the new truck requires a wide-ranging operator training programme. Included in the trucks purchase price is sufficient initial training to operate the truck for one year. Then, starting in 2023, the operator must receive additional training every second year. The training would normally be performed at NRWs Operator Training Centre (OTC). However, because the OTC is at capacity the training must occur at an external organisation for the foreseeable future at a cost of $45,000. If the OTC did have spare capacity then NRW could earn income by training operators from external organisations.

5. According to the consultant, the new truck could easily be operated for twenty years. However, NRW will operate the truck for ten years only. The existing truck can be sold for $440,000 today. If NRW do not purchase the new truck they will continue to operate the existing truck for a further ten years. The existing truck was purchased seven years ago for $2.9 million and is being depreciated over its ten-year tax life at the time of purchase.

6. Some NRW Board members suggest that as the new truck is analysed over a ten-year time period NRW must recover all the costs they have incurred to date. They recommend the $75,000 fee paid to the civil engineering consultant be included as a cash outflow in 2022.

7. NRW will borrow $2 million using a fully amortised ten-year loan at an interest rate of 5% per annum to partly finance the new truck. The loan requires annual interest payments of $259,009, starting in one years time.

8. Today, inventory will need to increase by $140,000 to $640,000, accounts receivable will increase to $750,000 from the current figure of $660,000, and current liabilities (in the form of short-term debt) will increase to a total of $800,000 compared to the current figure of $450,000. Accounts payable will remain at the current $433,000 figure.

9. The storage shed that NRW constructed in 2020 at a cost of $675,000 will be retained whether NRW purchases the new truck or not. This shed is being depreciated over its 20-year life assuming a salvage value of zero. The management group suggest the sheds annual depreciation expense of $33,750 be included in the financial analysis of the new truck.

10. At the moment, the existing truck generates annual cash sales of $1,700,000. This sales figure is predicted to remain constant for each of the next ten years. The new truck is predicted to generate cash sales of $2.7 million in 2023 and it is anticipated that this sales figure will increase by 4% per annum for the foreseeable future.

11. The CFO has gathered some information regarding current and expected operating costs. At the moment, fixed costs are $400,000 per annum. With the purchase of the new truck fixed costs would rise to $500,000 in year one and this figure will continue to increase by 2% p.a. Wages expense is currently $900,000 each year and is predicted to increase to $1.4 million with the introduction of the new truck. The CFO clarifies the importance of incremental cash flow items when performing a financial analysis.

12. The improved fuel economy of the new truck will allow NRW to reduce its current annual fuel expenditure by $40,000 compared to the existing truck. The existing truck was relatively fuel inefficient and used, on average, 290,000 litres of diesel fuel each year. The CFO assumes the cost of diesel fuel remains constant for the next ten years at $1.85 per litre.

13. The current annual maintenance cost of the existing truck is $63,000. The new truck will require no maintenance in the first two years of its life because it is covered by a manufacturers two-year warranty. However, after the warranty expires in year two the annual maintenance expense will be $87,000.

14. NRW recently updated its expectation for full-year (FY22) EBITDA by $5 million to $155 million.

15. According to the Australian Taxation Office (ATO) the new truck has a twenty-five year life for taxation purposes, and transportation is a tax-deductible business expense.

16. It costs $175,000 a year to operate NRWs Boggabri corporate office. With careful management NRW believes they will not require any additional personnel in the Boggabri office if they purchase the new truck. In any case, the operating expenses are assumed to increase by 3% p.a.

17. The accountant affirms that expenses incurred by NRW in generating revenue are tax deductible in the year the expense is incurred.

18. The civil engineers report estimates that the new truck will have a market value of $3 million in ten years time. The existing truck can be sold for $440,000 today. NRW will use these sale proceeds to distribute a special $440,000 dividend to its shareholders today. The consultant advises that in ten years time the existing truck would be worthless.

19. The company tax rate is 30% and the required rate of return is 12%. REQUIREMENTS Your team must answer the following questions.

QUESTION:

1. The cash flows at the end.

2. What is the NPV of the truck replacement decision, and your recommendation? Additional Information (5 Marks)