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- Nov 24th 2009, 06:20 AM #1

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- Nov 2009
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Ok, Below is a question from a project i have to do. I have the answer to 1 a, so don't worry about that one. 1b, is where i am having trouble. I know how to calculate IRR on my financial calculator, but i'm not sure what values I should be using. ie, should I subtract the tax rate, and the physical damage of the truck from the $10,000 cash infolw that I receive every year? Any help would be much appreciated! Thanks!!! (sorry its kind of long).

1. A construction firm has just purchased for $18,000 a truck that is expected to generate a before-tax annual net cash flow of $10,000 in each of the six years of its useful life, after which the truck is expected to have no salvage value. This expected annual net cash flow does not include any allowance for possible damage to the truck.

Because the truck is to be used on and off public roads, it is particularly subject to physical damage from both traffic and construction accidents. The annual amount of physical damage to this truck is described by the following probability distribution:

Probability

Annual Damage to truck

.60

$0

.30

1,000

.06

5,000

.04

18,000

a. What is the annual expected value of the physical damage to this truck? Show your calculations.

b. Assume, regardless of your answer in (a), that the annual expected value of physical damage to this truck is $1,400 and that the firm plans to retain any physical damage losses to the truck by paying them as current expenses. Refer to the following excerpt a table entitled “Present Value of $1 Received Annually at the End of Each of*n*Periods” to determine whether the use of this truck and the retaining of the annual expected value of physical damage to the truck will generate an after-tax internal rate of return greater than 22 percent rate of return the firm averages on its other assets. Assume straight-line depreciation and a 50 percent income tax rate. Show your calculations.

*n*

18%

20%

22%

24%

6

3.50

3.33

3.17

3.02

n 18% 20% 22% 24%

6 3.50 3.33 3.17 3.02

sorry, this is what the chart should look like.