Question

Edelman Engineering is considering including two pieces of equipment, a truck and an     overhead pulley system in this year’s capital budget. The projects are independent. The   cash outlay for the truck is $17,100 and for the pulley system it is $22,430. The firm’s cost of capital is 14%. After tax cash flows are as follows:

                                    Year                            Truck                           Pulley

                                    1                                  $5,100                         $7,500

                                    2                                  $5,100                         $7,500                                                                         3                                  $5,100                         $7,500                                                                         4                                  $5,100                         $7,500

                                    5                                  $5,100                         $7,500

            Calculate the PB, DPB in excel for each project. Indicate the correct accept or reject decision for each project.

Answer 1

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computation of payback period : Payback period is period were initial investment is recovered by cash flow.
					cumulative cash flow
	year	Truck	Pulley		Truck	Pulley
	0	-17100	-22430		-17100	-22430
	1	5100	7500		-12000	-14930
	2	5100	7500		-6900	-7430
	3	5100	7500		-1800	70
	4	5100	7500		3300	7570
	5	5100	7500		8400	15070
	Payback period Truck =			=3+1800/5100		3.35	year
	Payback period pulley =			=2+7430/7500		2.99	year
	Decision: Since Pulley has lower payback period therefore Pully should be accepted over Truck
computation of discounted payback period : discounted payback period is period were initial investment is recovered at discounted cash flow level.
		i	ii		iii	iv=i*iii	v=ii*iii		vi	vii
						Discounted cash flow			cumulative discounted cash flow
	year	Truck	Pulley		PVIF @ 14%	Truck	Pulley		Truck	Pulley
	0	-17100	-22430		1.0000	(17,100)	(22,430)		(17,100)	(22,430)
	1	5100	7500		0.8772	4,474	6,579		(12,626)	(15,851)
	2	5100	7500		0.7695	3,924	5,771		(8,702)	(10,080)
	3	5100	7500		0.6750	3,442	5,062		(5,260)	(5,018)
	4	5100	7500		0.5921	3,020	4,441		(2,240)	(577)
	5	5100	7500		0.5194	2,649	3,895		409	3,318
	Payback period Truck =			=4+2240/2649		4.85	year
	Payback period pulley =			=4+577/3895		4.15	year
	Decision: Since Pulley has lower discounted payback period therefore Pully should be accepted over Truck