Question

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The management of Iroquois National Bank is considering an investment in automatic teller machines. The machines would cost $131,100 and have a useful life of seven years. The bank’s controller has estimated that the automatic teller machines will save the bank $28,500 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.)

Payback period4.6years

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.)

	Net Present Value (a) 10 percent (b) 12 percent (c) 14 percent

3.	Which of the following statements are true? (Select all that apply.)
	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 4.6 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

Payback period = Initial cost/Annual inflows

= 131,100/28,500

= 4.6 years

Net Present value = Present value of cash inflows – present value of cash outflows

At 10%, NPV = 28,500*PVAF(10%, 7 years) – 131,100

= 28,500*4.868 – 131,100

= $7,638

At 12%, NPV = 28,500*4.564 – 131,100

= -$1,026

At 14%, NPV = 28,500*4.288 – 131,100

= -$8,892

The correct statements are

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 4.6 years or more

The cut-off value for the payback period has nothing to do with the bank's hurdle rate