Novak 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 $56,100. Because of the increased capacity, reduced
maintenance costs, and increased fuel economy, the new truck is
expected to generate cost savings of $8,200. At the end of 8 years,
the company will sell the truck for an estimated $28,500.
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%.
Click here to view PV table.
(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 e.g. -45
or parentheses e.g. (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?
YesNo |
Does it meet the net present value criteria for acceptance?
Cash payback period calculation:
Year | Cash flows | Incremental cash flows |
1 | $8,200 | $8,200 |
2 | $8,200 | $16,400 |
3 | $8,200 | $24,600 |
4 | $8,200 | $32,800 |
5 | $8,200 | $41,000 |
6 | $8,200 | $49,200 |
7 | $8,200 | $57,400 |
8 | $8,200 + $28,500 | $94,100 |
Till 6 years $49,200 is collected.
Remaining amount to be collected for payback = $56,100 - $49,200 = $6,900
For collecting $6,900, time required is = $6,900 / $8,200 = 0.8
(a)
Cash payback period = 6 years + 0.8 year = 6.8 years
Net present value = ($8,200 X 5.74664) + ($28,500 X 0.54027) - $56,100 = $6,420
(b)
The desired cash payback period is 50% of 8 years. ie. 4 years is the desired cash payback period.
But the actual cash payback period is 6.8 years.
NO. The project didn’t meet the companies cash payback criteria.
Net present value is positive. YES, The project can be accepted.
Novak Corporation is considering purchasing a new delivery truck. The truck has many advantages over the...
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