Palo Alto Corporation is considering purchasing a new delivery truck. The truck
ID: 2452466 • Letter: P
Question
Palo Alto 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 $57,000. Because of the increased capacity, reduced maintenance costs, and increased fuel economy, the new truck is expected to generate cost savings of $8,430. At the end of 8 years the company will sell the truck for an estimated $27,830. 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%.
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.)
Cash payback period _____ years
Net present value $ _______
Explanation / Answer
Cash payback period is 6.8 years Ans
Net Present Value is $ 6,475 Ans
Assumption is that the current truck has no resale value.
Cash payback period is calculated as Initial investment / annual cash savings. Therefore in this case it is
$ 57,000/ 8430 = 6.76 years rounded off to 6.8 years.
Net Present Value is calculated as present value of cash inflows/ cash earnings less the present value of cash outflows.
Present value of cash inflows/incremental earnings = $ 8430 x 5.747 = $ 48447.21
Present value of resale value of new truck = $ 27,830 x 0.540 = $ 15,028.20
Therefore, total present of cash inflows = $ (48447.2 +15028.20) = $63475.40
Hence Net Present Value of the new truck is $ ( 63475.40 - 57,000) = $ 6475.40 rounded off to $ 6475
The present value factor of one $ at 8% cost of capital at the end of 8 years is 0.540 (Table A 3)
The present value factor of an annuity of one $ at 8 % cost of capital for 8 years is 5.747 ( Table A 4)
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