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Question 1 Open Show Work Question 1 Linkin Corporation is considering purchasin

ID: 2587503 • Letter: Q

Question

Question 1

Open Show Work

Question 1

Linkin 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 $56,800. Because of the increased capacity, reduced maintenance costs, and increased fuel economy, the new truck is expected to generate cost savings of $8,300. At the end of 8 years the company will sell the truck for an estimated $27,200. 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%.

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(a)

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. For calculation purposes, use 5 decimal places as displayed in the factor table provided.)
Cash payback period

years Net present value $


(b)

Does the project meet the company’s cash payback criteria?

NoYes


Does it meet the net present value criteria for acceptance?

YesNo

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Explanation / Answer

Nominal Payback

Year

Headings

Cash Flow

Discount Rate @ 8%

Discounted Cash flows

Discounted Cumulative Cash flows

0

Initial Investment

-56800

1.0000

-56800.00

-56800.00

1

Annual Savings

8300

0.9259

7685.19

-49114.81

2

Annual Savings

8300

0.8573

7115.91

-41998.90

3

Annual Savings

8300

0.7938

6588.81

-35410.10

4

Annual Savings

8300

0.7350

6100.75

-29309.35

5

Annual Savings

8300

0.6806

5648.84

-23660.51

6

Annual Savings

8300

0.6302

5230.41

-18430.10

7

Annual Savings

8300

0.5835

4842.97

-13587.13

8

Annual Savings

8300

0.5403

4484.23

5592.42

8

Salvage Value

27200

0.5403

14695.31

NPV

5592.42

Discounted Payback

=7 + (13587.13/19179.55)

7.7084

Year

(a) Cash payback period      = 7.71 Years

(Discounted)

NPV                                       = $ 5592.42

(b) 1. No. Company does not meet the company’s payback criteria of payback of less than 50% life of asset i.e. less than 4 years (50% of 8 years life of truck) in this case.

(b) 2. Yes. Company’s net present value criteria does meet hence it could be accepted.

Nominal Payback

Year

Headings

Cash Flow

Discount Rate @ 8%

Discounted Cash flows

Discounted Cumulative Cash flows

0

Initial Investment

-56800

1.0000

-56800.00

-56800.00

1

Annual Savings

8300

0.9259

7685.19

-49114.81

2

Annual Savings

8300

0.8573

7115.91

-41998.90

3

Annual Savings

8300

0.7938

6588.81

-35410.10

4

Annual Savings

8300

0.7350

6100.75

-29309.35

5

Annual Savings

8300

0.6806

5648.84

-23660.51

6

Annual Savings

8300

0.6302

5230.41

-18430.10

7

Annual Savings

8300

0.5835

4842.97

-13587.13

8

Annual Savings

8300

0.5403

4484.23

5592.42

8

Salvage Value

27200

0.5403

14695.31

NPV

5592.42

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