Question

Lotus Engineering is considering including two pieces of equipment, a truck and an overhead pulley system, in this year’s capital budget. The projects are independent. The firm’s cost of capital is 12%. The after tax cash flows, including depreciation, for the truck and the pulley are as follows:

Year Truck Pulley
0 -50,000 -70,000
1 10,000 15,000
2 10,000 15,000
3 10,000 15,000
4 10,000 15,000
5 10,000 15,000
6 10,000 15,000
7 10,000 15,000
2a. What is the payback period for the truck?
2b. What is the payback period for the pulley?
2c. What is NPV for the truck?
2d. What is NPV for the pulley?

Answer 1

The payback period for the truck and pulley is 5 years. The NPV for the truck is $31,393.99 and for the pulley is $51,881.79.

Step-by-step explanation:

To calculate the payback period for the truck, we need to determine the time it takes for the cash inflows to recover the initial investment. Looking at the cash flows, the truck costs $50,000 in year 0 and generates $10,000 in cash flow each year from year 1 to year 7. Calculating the cumulative cash flow, we find that it takes 5 years for the cash inflows to equal or exceed the initial investment of $50,000. Therefore, the payback period for the truck is 5 years.

To calculate the payback period for the pulley, we use the same method. The pulley costs $70,000 in year 0 and generates $15,000 in cash flow each year from year 1 to year 7. Calculating the cumulative cash flow, we find that it takes 5 years for the cash inflows to equal or exceed the initial investment of $70,000. Therefore, the payback period for the pulley is also 5 years.

To calculate the NPV (Net Present Value) for the truck, we discount each cash flow by the firm's cost of capital, which is 12%. Using the formula NPV = CF1/(1+r)^1 + CF2/(1+r)^2 + ... + CFn/(1+r)^n, where CF is the cash flow and r is the discount rate, we find that the NPV for the truck is $31,393.99.

Similarly, to calculate the NPV for the pulley, we discount each cash flow by the firm's cost of capital. Using the same formula, we find that the NPV for the pulley is $51,881.79.