Dobbs Corporation is considering purchasing a new delivery truck. The truck has

Question

Dobbs 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 $55,800. Because of the increased capacity, reduced maintenance costs, and increased fuel economy, the new truck is expected to generate cost savings of $9,040. At the end of 8 years the company will sell the truck for an estimated $27,720. 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. Hal Michaels, 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%.


Compute the cash payback period and net present value of the proposed investment

Payback period ? years
Net present value $ ?

Does the project meet the company's cash payback criteria?
Does it meet the net present value criteria for acceptance?
Should the project be accepted?

Explanation / Answer

ayback Periode: Investment = $56,000 Solvage Value = $28,000 Net Investment = $28,000 Yearly Saving = $8,000 Payback Periode = Net Investment / Yearly Savings = 28000 / 8000 = 3.5 Years Net Present Value: Years Savings PV. Factor Discounted Cash Flows 1 8000 0.925925926 7407.407407 2 8000 0.85733882 6858.710562 3 8000 0.793832241 6350.657928 4 8000 0.735029853 5880.238822 5 8000 0.680583197 5444.665576 6 8000 0.630169627 5041.357015 7 8000 0.583490395 4667.923162 8 8000 0.540268885 4322.151076 Total Cash Inflows 45973 Less: Net Invest Ment 28000 Net Present Value: 17973 = $17,973 PV. Factor = 1 / 1 + Discount Rate^Years Does the project meet the company's cash payback criteria? No Does it meet the net present value criteria for acceptance? Yes Should the project be accepted? Yes

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