Mateo Corporation is considering purchasing a new delivery truck. The truck has
ID: 2371856 • Letter: M
Question
Mateo 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 $56,810. Because of the increased capacity, reduced maintenance costs, and increased fuel economy, the new truck is expected to generate cost savings of $9,090. At the end of 8 years the company will sell the truck for an estimated $28,250. 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. Nathan Levitt, 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%.Mateo 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 $56,810. Because of the increased capacity, reduced maintenance costs, and increased fuel economy, the new truck is expected to generate cost savings of $9,090. At the end of 8 years the company will sell the truck for an estimated $28,250. 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. Nathan Levitt, 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%. Compute the cash payback period and net present value of the proposed investment. Mateo 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 $56,810. Because of the increased capacity, reduced maintenance costs, and increased fuel economy, the new truck is expected to generate cost savings of $9,090. At the end of 8 years the company will sell the truck for an estimated $28,250. 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. Nathan Levitt, 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%.
Explanation / Answer
Payback period:55770/8290 = 6.7Payback period = 6.7 yearsNet present value:PV of salvage value = 28,100*0.54027 = 15181.59PV of cost savings = 8290*5.74664 = 47639.65NEt presnet value = 15181.59 + 47639.65 - 55770 = 7051.24Payback period = 6.7 yearsNet present value = $7051
or
http://e-enterprisezone.com/old/mn412/npvcalc.htmlAt year 8, the inflow will then be $8,690 + 27,710 = 36,400.You can see the calculation here:For the payback period, you want to find out when the sum of the future inflows equal the initial outflow. This is at 8690x=57010x = 6.56 years (if you are not taking into account the discount rate. However, it takes all 8 years to be paid back if you do take that into account.
or
NPV Method:NPV of the project is positive i.e.$5,222.9389 and it should be accepted under NPV method.Where as if the company sticks to its earlier method of project appraisal i.e. Payback period the company is recovering the amount in 7th year i.e.$55930.the company would have rejected the offer.
or
payback period = 56,420/8990 = 6.3net present value:-56420+ 51662 (5.74664*8990)+ 15106 (27960/1.08^8)= 10348