Palo Alto Corporation is considering purchasing a new delive

Palo Alto 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 $56,740. Because of the increased capacity, reduced maintenance costs, and increased fuel economy, the new truck is expected to generate cost savings of $8,220. At the end of 8 years the company will sell the truck for an estimated $27,940. 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 the factor table.

(For calculation purposes, use 5 decimal places as displayed in the factor table provided.)

Palo Alto 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 $56,740. Because of the increased capacity, reduced maintenance costs, and increased fuel economy, the new truck is expected to generate cost savings of $8,220. At the end of 8 years the company will sell the truck for an estimated $27,940. 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 the factor table. (For calculation purposes, use 5 decimal places as displayed in the factor table provided.)

Solution

a)Payback desired = useful life *%

           = 8*.50

             = 4 years or less

Payback period = Initial cost /annual cost savings

    = 56740/8220

     = 6.9 years

b)Present value of cash flow =[PVA 8%,8*Annual cost savings] +[PVF 8%,8*sale value ]

= [5.74664*8220]+[.54027*27940]

= 47237.38+ 15095.14

= 62332.52   [rounded to 62333]

NPV =Present value -initial cost

= 62333 - 56740

= 5593