Question

Sandhill 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 $55,040. Because of the increased capacity, reduced maintenance costs, and increased fuel economy, the new truck is expected to generate cost savings of $8,600. At the end of 8 years, the company will sell the truck for an estimated $28,900. 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 PV table. (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 $

Answer 1

The cash payback period for the new truck is 6.4 years, and the net present value is $6,640.33. This means that the cost savings from the new truck will recoup the initial cost in 6.4 years, and the investment has a positive net present value.

The cash payback period is the time it takes for an investment to recoup its initial cost through cash inflows. To calculate the cash payback period, we need to determine how long it will take for the cost savings to equal the initial cost of the truck.

Using the cost savings of $8,600 per year, the cash payback period can be calculated as follows :

$55,040 (initial cost) ÷ $8,600 (annual cost savings) = 6.4 years.

The net present value (NPV) is a method used to evaluate the profitability of an investment by comparing the present value of cash inflows to the present value of cash outflows. To calculate the NPV, we need to discount the cash inflows and outflows using the company's cost of capital. In this case, the cost of capital is 8%.

For the new truck, the cash inflows include the cost savings of $8,600 per year and the cash outflows include the initial cost of $55,040.

Discounting these cash flows over an 8-year period using a discount rate of 8% gives a NPV of $6,640.33.

Therefore, the cash payback period is 6.4 years and the net present value is $6,640.33.