E12-1 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%.
Instructions
(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? Should the project be accepted? Discuss your results.
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