Exercise 24-1 (part level submission) Palo Alto Corporation is considering purch

Question

Exercise 24-1 (part level submission) 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 $56,640. 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 $27,850. 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%.

Explanation / Answer

Payback period = ($56640 - $27850) (Capital Investment) / $8400 (Cash Inflow) Payback period = 3.43 Years Calculation of NPV of Project Particulars Year Amount 8% Factor Present value C D C X D Cash Inflow Net Cash Inflow 1 -8            8,400         5.7466                48,272 Salavage Value 8          27,850         0.5403                15,047 A. Total Cash Inflow - PV                63,319 Cash Outflow Cost of Truck 0          56,640         1.0000                56,640 B. Total Cash Outflow - PV                56,640 NPV (A - B)                  6,679

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