Question

The management of Iroquois National Bank is considering an investment in automatic teller machines. The machines would cost $134,400 and have a useful life of seven years. The bank’s controller has estimated that the automatic teller machines will save the bank $28,000 after taxes during each year of their life (including the depreciation tax shield). The machines will have no salvage value.

Use Appendix A for your reference. (Use appropriate factor(s) from the tables provided.)

Required:

1.Compute the payback period for the proposed investment. (Round your answer to 1 decimal place.) 2. Compute the net present value of the proposed investment assuming an after-tax hurdle rate of: (a) 10 percent, (b) 12 percent, and (c) 14 percent. (Negative amounts should be indicated by a minus sign. Round your final answers to the nearest dollar amount.)    3. Which of the following statements are true? The net-present-value method is preferable to the payback method.checkbox unchecked1 of 6 The payback method is preferable to the net-present-value method.checkbox unchecked2 of 6 The payback period criterion fails to account for the time value of money.checkbox unchecked3 of 6 If management uses the payback method, the investment will be approved only if the required payback period is 4.8 years or more.checkbox unchecked4 of 6 The cut-off value for the payback period is very much dependent on the bank's hurdle rate.checkbox unchecked5 of 6 The cut-off value for the payback period has nothing to do with the bank's hurdle rate.checkbox unchecked6 of 6

Answer 1

Solution 1:

Initital investment = $134,400

Annual cash inflows = $28,000

Payback period = Initial investment / Annual cash inflows = $134,400 / $28,000 = 4.8 year

Solution 2:

Computation of NPV - Iroquois National Bank
Particulars	Amount	Period	Hurdle rate - 10%		Hurdle rate - 12%		Hurdle rate - 14%
			PV Factor	Present Value	PV Factor	Present Value	PV Factor	Present Value
Cash Outflows:
Cost of Investment	$134,400.00	0	1	$134,400	1	$134,400	1	$134,400
Present Value of Cash Outflows (A)				$134,400		$134,400		$134,400
Cash Inflows:
Annual cash inflows	$28,000.00	1-7	4.868419	$136,316	4.563757	$127,785	4.288305	$120,073
Present Value of Cash Inflows (B)				$136,316		$127,785		$120,073
Net Present Value (B-A)				$1,916		-$6,615		-$14,327

Solution 3:

True statements are as under:

The net-present-value method is preferable to the payback method.

The payback period criterion fails to account for the time value of money.

If management uses the payback method, the investment will be approved only if the required payback period is 4.8 years or more

The cut-off value for the payback period is very much dependent on the bank's hurdle rate.