Question

Linkin Corporation is considering purchasing a new delivery truck. The truck has many advantages over the company’s current truck (not the least of which is that it runs). The new truck would cost $54,760. Because of the increased capacity, reduced maintenance costs, and increased fuel economy, the new truck is expected to generate cost savings of $7,400. At the end of 8 years, the company will sell the truck for an estimated $27,000. Traditionally the company has used a rule of thumb that a proposal should not be accepted unless it has a payback period that is less than 50% of the asset’s estimated useful life. Larry Newton, a new manager, has suggested that the company should not rely solely on the payback approach, but should also employ the net present value method when evaluating new projects. The company’s cost of capital is 8%.
Compute the cash payback period and net present value of the proposed investment.

Answer 1

If only Cash Payback Period is considered, the investment proposal should not be accepted, as it is mentioned that the company has used a rule of thumb that a proposal should not be accepted unless it has a payback period that is less than 50% of the asset’s estimated useful life. 7.4 years is not less than 50% of asset's useful life.

As per the question, Larry Newton, a new manager, has suggested that the company should not rely solely on the payback approach, but should also employ the net present value method when evaluating new projects. Hence, if we consider net present vale method, Since NPV is positive, the company can go for the investment.

Present Value Factors: