Question

Bob Heavy Tools is considering the acquisition of a light truck, in order to expand the business to other geographical areas. If he can expand to other areas, additional business will represents an increase in Earnings before depreciation and taxes of $60,000 annually during the first 3 years and $25,000 annually in the last 3 years. Bob’s cost of capital is 12% and is in the 32% marginal tax rate. If the light truck cost is $160,000, What is the net present value?

Answer 1

The net present value (NPV) of the light truck acquisition for Bob Heavy Tools can be calculated using the formula:

`\[ NPV = \sum_(t=1)^(n) (CF_t)/((1 + r)^t) - C_0 \]`

where
`\( CF_t \)` is the net cash inflow during the period t, r is the discount rate, t is the period, n is the total number of periods, and
`\( C_0 \)` is the initial investment cost.

Step-by-step explanation:

In this case, the net cash inflow (
`\( CF_t \)`) represents the additional earnings before depreciation and taxes (EBDT) generated by the expansion. The cash inflows are $60,000 annually for the first 3 years and $25,000 annually for the last 3 years. The discount rate (r) is the cost of capital, which is 12%, and the initial investment (
`\( C_0 \)`) is the cost of the light truck, $160,000.

Substitute these values into the NPV formula:

`\[ NPV = (60,000)/((1 + 0.12)^1) + (60,000)/((1 + 0.12)^2) + (60,000)/((1 + 0.12)^3) + (25,000)/((1 + 0.12)^4) + (25,000)/((1 + 0.12)^5) + (25,000)/((1 + 0.12)^6) - 160,000 \]`

Now, calculate the present value of each cash inflow and subtract the initial investment to find the NPV. The result will indicate whether the acquisition is a financially sound investment for Bob Heavy Tools.