Question

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 $57,500. Because of the increased capacity, reduced maintenance costs, and increased fuel economy, the new truck is expected to generate cost savings of $8,300. At the end of 8 years the company will sell the truck for an estimated $28,800. 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

Answer 1

Answer a Calculation of Cash Payback Period Cash Payback Period = $57,500 / $8,300 = 6.9 years Calculation of Net Present Value Cash Flows $8,300 $28,800 8% Discount Factor 5.74664 0.54027 X X X Present Value of Net Annual Cash Flows Present Value of Salvage Value = = = Present Value $47,697 $15,560 $63,257 ($57,500) $5,757 Less: Capital Investment Net Present Value b The Company does not meet the company's cash payback criteria. The project would have to have a cash payback period of less than (8 years / 2) = 4 years. So it does not meet this criteria. Company has meet the Net Present Value Criteria, so the Company should accept the Project.