Exercise 12-1 (Part Level Submission) (a) Exercise 12-1 (Part Level Submission)

Question

Exercise 12-1 (Part Level Submission)

(a)

Exercise 12-1 (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 $56,260. Because of the increased capacity, reduced maintenance costs, and increased fuel economy, the new truck is expected to generate cost savings of $8,260. At the end of 8 years the company will sell the truck for an estimated $28,350. 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%.
(Refer the below table).

Explanation / Answer

Payback Period = Cost of Project / Annual Cash Inflows Cost of project = [Cost-Slavage Value] =56250-28350 27900 $ Annual Cash flows = Annual Savings = $8260 Payback Period = Cost of Project / Annual Cash Inflows =27900/$2850*100 9.789474 NPV = PVCI-PVCO = 47467-40943 6524 $ Calulation of PV of cashoutflow Particulars Year PVF Amount Present Value Cost of truck 0 1        56,260                    56,260 Salvage Value 8 0.540269     (28,350)                 (15,317) TOTAL        27,910                    40,943 Calulation of PV of INflow Particulars Year PVF Amount Present Value Cost Saving 01-08 5.746639          8,260                    47,467 TOTAL          8,260                    47,467

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