Palo Alto Corporation is considering purchasing a new delivery truck. The truck
ID: 2487402 • 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 $56,500. Because of the increased capacity, reduced maintenance costs, and increased fuel economy, the new truck is expected to generate cost savings of $8,130. At the end of 8 years the company will sell the truck for an estimated $28,330. 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 the factor table. (For calculation purposes, use 5 decimal places as displayed in the factor table provided.) 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.) Does the project meet the company's cash payback criteria? Does it meet the net present value criteria for acceptance?Explanation / Answer
Cash Payback period = Initial Investment/Annual cash flows after tax
= $56500/8130
= 6.95 years
NPV = Present value of cash inflows - Present value of cash outflows
= 8130 X PVAF@8%1-8 + 28330 x PVF @8%5 - 56500
= 8130 x 5.747 + 28330 x 0.540 - 56500
= 5521.31
Since Payback back period os more than 50% of the project's life, it meets the criteria of Payback period
Since NPV is positive, it meets the criteria of NPV
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