You have been asked by the president of your company to evaluate the proposed acquisition of a new special-purpose truck. The truck's basic price is $50,000, and it will cost another $10,000 to modify it for special use by your firm. The truck falls into the MACRS three-year class, and it will be sold after three years for
$20,000. Use of the truck will require an increase in net working capital (spare parts inventory) of $2,000. The truck will have no effect on revenues, but it is expected to save the firm $20,000 per year in before-tax operating costs, mainly labor. The firm's marginal tax rate is 40 percent. What is the net investment in the truck?
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A. B. C. D. E.Explanation
Initial investment:
Cost($50,000)
Modification(10,000)
Change in NWC(2,000)
Total net investment =($62,000)
To calculate the net investment in the truck, we need to consider the initial cost of the truck, the cost of modifications, the increase in net working capital, and the salvage value.
Initial Cost: The basic price of the truck is $50,000.
Cost of Modifications: It will cost an additional $10,000 to modify the truck for special use.
Increase in Net Working Capital: The use of the truck will require an increase in net working capital (spare parts inventory) of $2,000.
Salvage Value: After three years, the truck will be sold for $20,000.
To calculate the depreciation expense, we will use the Modified Accelerated Cost Recovery System (MACRS) three-year class. The MACRS depreciation percentages for a three-year class are as follows: Year 1: 33.33% Year 2: 44.45% Year 3: 14.81% Year 4: 7.41% (assuming no salvage value)
Now let's calculate the depreciation expense for each year: Year 1: $50,000 * 33.33% = $16,665 Year 2: ($50,000 - $16,665) * 44.45% = $14,441.18 Year 3: ($50,000 - $16,665 - $14,441.18) * 14.81% = $5,451.80
The total depreciation expense over three years is $16,665 + $14,441.18 + $5,451.80 = $36,558.98.
Next, we calculate the tax savings from depreciation. Since the firm's marginal tax rate is 40%, the tax savings from depreciation is: Tax Savings = Depreciation Expense * Tax Rate Tax Savings = $36,558.98 * 40% = $14,623.59
The net investment in the truck is the total cost minus the tax savings from depreciation: Net Investment = (Initial Cost + Modifications + Net Working Capital) - Tax Savings Net Investment = ($50,000 + $10,000 + $2,000) - $14,623.59 Net Investment = $62,000 - $14,623.59 = $47,376.41
Therefore, the correct answer is not provided among the options. The correct net investment in the truck is $47,376.41, which is not listed.