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 $56,900. Because of the increased capacity, reduced maintenance costs, and increased fuel economy, the new truck is expected to generate cost savings of $8,400. At the end of 8 years the company will sell the truck for an estimated $28,400. 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 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? Does it meet the net present value criteria for acceptance?

Answer 1

Requirement (a):

Cash payback period	6.11 Years
Net present value	$6,715

Calculations:

i. Calculation of cash payback period:

Year	Cash flows	Accumulated cash flows
1	$8,400	$8,400
2	$8,400	$16,800
3	$8,400	$25,200
4	$8,400	$33,600
5	$8,400	$42,000
6	$8,400	$50,400
7	$8,400	$58,800
8	$36,800*	$95,600

* 8th year inclusive of $8,400 (cost savings) and $28,400 (salvage value). i.e.:36,800

Cash payback period = 6 years + [56,900-50,400] ÷ 58,800

= 6 Years + [6,500/58,800]

= 6 Years + 0.11

= 6.11 Years

ii. Calculation of Net present value:

Present value of cash flows
Year	Cash flows	x	Present value factor @ 8%	=	Present value
1	$8,400	x	0.92593	=	$7,777.81
2	$8,400	x	0.85734	=	$7,201.66
3	$8,400	x	0.79383	=	$6,668.17
4	$8,400	x	0.73503	=	$6,174.25
5	$8,400	x	0.68058	=	$5,716.87
6	$8,400	x	0.63017	=	$5,293.43
7	$8,400	x	0.58349	=	$4,901.32
8	$8,400	x	0.54027	=	$4,538.27
8	$28,400	x	0.54027	=	$15,343.67
Total					$63,615

Present value of cash flows	$63,615
(Less): Initial investment (cost of truck)	($56,900)
Net present value	$6,715

Requirement (b):

No,

It does not meet the company's cash payback period as it exceeds 50% of the asset's estimated useful life.

Yes,

It meet the present value criteria for acceptance as it Net present value is Positive.