Question

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 $55,440. Because of the increased capacity, reduced maintenance costs, and increased fuel economy, the new truck is expected to generate cost savings of $8,400. At the end of 8 years, the company will sell the truck for an estimated $27,700. 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%.

Answer 1

The payback period of the investment is 6.6 years.

The net present value is $7,797.22.

The payback period calculates the amount of time it takes to recover the amount invested from the cumulative cashflows.

Payback period = Amount invested / cost saving

$55,440 / $8,400 = 6.6 years

Net present value is the present value of after-tax cash flows from an investment less the amount invested.  

NPV can be determined using a financial calculator

Cash flow in year 0 = $-55440

Cash flow in year 1 to 7 = $8,400

Cash flow in year 8 = $8400 + $27,700

I = 8%

NPV = $7,797.22

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