Question

Eat at State is considering buying a new food truck. It will cost $65,000, but is expected to generate $20,000 in sales over the next 4 years. At the end of the 4th year, the truck will be sold to Eat Like a Wolverine in Ann Arbor for $10,000 (after taxes). It will require $5,000 in additional Net Working capital that will not be recovered when the truck is sold. The Dean of Food Services will only authorize the purchase if it is cash positive by the end of the 4th year. Using the payback period method, should the truck be purchased, and why

Answer 1

The payback period method is used to determine whether the food truck purchase is cash positive by the end of the 4th year. Calculating the payback period involves determining the net cash inflow for each year until the initial investment is fully recovered. In this case, the payback period is 2 years, which is less than the 4-year requirement set by the Dean of Food Services. Therefore, the food truck should be purchased.

Step-by-step explanation:

To determine whether the food truck purchase is cash positive by the end of the 4th year using the payback period method, we need to calculate the payback period. The payback period is the time it takes for the initial investment to be recovered. In this case, the initial investment is $65,000. To calculate the payback period, we need to determine the net cash inflow for each year until the initial investment is fully recovered.

Year 1: Sales - Additional Working Capital = $20,000 - $5,000 = $15,000

Year 2: Sales = $20,000

Year 3: Sales = $20,000

Year 4: Sales + Salvage Value - Additional Working Capital = $20,000 + $10,000 - $5,000 = $25,000

The cumulative net cash inflow for each year is:

Year 1: $15,000

Year 2: $35,000

Year 3: $55,000

Year 4: $80,000

The payback period is the year in which the cumulative net cash inflow equals or exceeds the initial investment ($65,000). In this case, the payback period is 2 years, as the cumulative net cash inflow reaches $65,000 in Year 2. Since the payback period is less than 4 years, the truck should be purchased.

Answer 2

It is not advisable to buy the food truck, since over the 4 years of investment it will show a loss of $ 40,000.

Step-by-step explanation:

Since Eat at State is considering buying a new food truck, and it will cost $ 65,000, but is expected to generate $ 20,000 in sales over the next 4 years, and at the end of the 4th year, the truck will be sold to Eat Like a Wolverine in Ann Arbor for $ 10,000 (after taxes), and it will require $ 5,000 in additional Net Working capital that will not be recovered when the truck is sold, and the Dean of Food Services will only authorize the purchase if it is cash positive by the end of the 4th year, to determine, using the payback period method if the truck should be purchased and why, the following calculation must be performed:

-65,000 + 20,000 + 10,000 - 5,000 = X

-70,000 + 30,000 = X

-40,000 = X

Therefore, it is not advisable to buy the food truck, since over the 4 years of investment it will show a loss of $ 40,000.