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 $55,400. Because of the increased capacity, reduced maintenance costs, and increased fuel economy, the new truck is expected to generate cost savings of $7,700. At the end of 8 years the company will sell the truck for an estimated $27,500. 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			enter the cash payback period in years rounded to 1 decimal place years
Net present value		$	enter the net present value in dollars rounded to 0 decimal places

(b)

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

select between Yes or No                                                          YesNo

Does it meet the net present value criteria for acceptance?

select between Yes or No                                                          YesNo

Answer 1

Requirement a:-

The Cash payback period is calculated using the following formula:-

=Cost of the Asset/Yearly Cash flows

Cost of the Asset = $55,400

Yearly Cash flow = $7,700

Payback Period = $55,400/$7,700 = 7.19 years

Payback period = 7.2 years(Rounded)

The Net Present value is calculated using the following formula:-

=Present Value of Cash inflows + Present value of Salvage Proceeds - Present value of Cash outflows

Present Value of Cash inflows = $7,700 * PVIFA(8 years, 8%) = $7,700 * 5.7466 = $44,249 - A

Present Value of Salvage value = $27,500 * PVIF (8 years, 8%) = $27,500 * 0.5403 = $14,858 - B

Present value of Cash inflows = $59,107

Present Value of Cash outlfows = $55,400

Net Present Value = $59,107 - $55,400

Net Present Value = $3,707

Requirement B:-

The Project does not meet the company's Payback criteria as the payback period calculated above for the project is 7.19 years which is significantly higher than the company's requirement of 4 years(8 years * 50%). Hence the answer is "No"

The Project meets the company's Net Present Value criteria as the company has a positive Net present value of $3,707. Hence the answer is "Yes"

Answer 2

(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			55400/7700 = 7.2 Years
Net present value		$	(7700*5.74664+27500*.54027)-55400 = 3707

(b)

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

No

Does it meet the net present value criteria for acceptance?

Yes