Question

Swifty 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 $57,270. Because of the increased capacity, reduced maintenance costs, and increased fuel economy, the new truck is expected to generate cost savings of $8,300. At the end of 8 years, the company will sell the truck for an estimated $28,800. 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%.

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(a)

Compute the cash payback period and net present value of the proposed investment. (If the net present value is negative, use either a negative sign preceding the number eg -45 or parentheses eg (45). Round answer for present value to 0 decimal places, e.g. 125. Round answer for Payback period to 1 decimal place, e.g. 10.5. For calculation purposes, use 5 decimal places as displayed in the factor table provided.)

Cash payback period			years
Net present value		$

(b)

Does the project meet the company’s cash payback criteria?

NoYes

Does it meet the net present value criteria for acceptance?

NoYes

Answer 1

(a)

Cash payback period is time period within which initial outlay will be received back in form of cash inflow

=initial outlay/ cash inflow

=$57,270/$8,300

=6.9 years

in order to accept the project payback period < 50%*8 = 4 years

However payback per iod is 6.9 years , so No, project does not meet the company’s cash payback criteria.

NPV = -Initial outlay-present value of cash flows

discount rate = 8%

As there is uniform series of cash flow each year we will use present value annuity factor

Year	cash flow	PV factor at 8%	Present value of cash flow
1-8	$8,300	5.74664[1/1.08]^1+[1/1.08]^2+[1/1.08]^3+[1/1.08]^4+[1/1.08]^5+[1/1.08]^6+[1/1.08]^7+[1/1.08]^8	$47,697.112[$8,300*5.74664]
8	$28,800	0.54027[1/1.08]^8	$15,559.776
		Less initial oiutlay	($57,270)
		NPV	$5,987

As the NPV IS POSITIVE AT 8% YES it meet the net present value criteria for acceptance

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