Question

Exercise 24-1

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 $57,300. Because of the increased capacity, reduced maintenance costs, and increased fuel economy, the new truck is expected to generate cost savings of $7,500. At the end of 8 years the company will sell the truck for an estimated $28,100. 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?

Yes
No

Does it meet the net present value criteria for acceptance?

Yes
No

Answer 1

(a)Cash payback period

Pay back period = Initial Investment / Cash flow

                             = $57,300 / $7,500

                             = 7.64 Years

(a)Net present value (NPV) at 8% = $982

Net Present Value = Present Value of cash flow + Present Value on salvage value – Initial Investment

= [ ($7500 x 5.74664 ) + ($7500 x 0.54027 )] - $57300

= $43100 + $15182 - $57300

= $982

(b)Does the project meet the company’s cash payback criteria?

No. The company has not met the company’s cash payback criteria. The company’s expected payback period is less than 50% of it’s useful life (Which means less than 4 Years) and the calculated payback period is 7.64 Years which exceeds the company’s expectation

Does it meet the net present value criteria for acceptance?

YES. The company met the net present value criteria since the NPV is positive $982