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NPV and Payback Period for Dobbs Corporation's Proposed Investment

Dobbs 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 $56,000. Because of the increased capacity, reduced maintenance costs, and increased fuel economy, the new truck is expected to generate cost savings of $8,000. At the end of 8 years the company will sell the truck for an estimated $28,000. 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. Hal Michaels, 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%.

A) Compute the cash payback period and net present value of the proposed investment.
B) Does the project meet the company's cash payback criteria? Does it meet the net present value criteria for acceptance? Discuss your results.

Solution Preview

Please refer attached file for better clarity of table.

A) Compute the cash payback period and net present value of the proposed investment.

Cost of truck=$56,000
Annual Savings=$8,000
Useful life=8 years
Cost of capital=8%
Salvage Value at the end of 8 years=$28,000

Let us study cash flows

Year End Cash inflow Cash outflow Net Cash flow Cumulative PV Factor PV of Net Cash flow
n Ci Co C=Ci-Co Cash flow =1/(1+8%)^n C*PVF
0 0 56000 -56000 ...

Solution Summary

This solution describes the steps to calculate NPV and payback period for the given investment proposal. A table of cash flows is provided in an attached Excel sheet to student the student how the present value of cash flows are determined in a step-by-step manner.

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