The following information is available to use in deciding whether to purchase the new backhoes or old backhoes. Using the 8% Present Value of an Annuity of 1. Old Backhoes New Backhoes Purchase cost when new $90,000 $200,000 Salvage value now $42,000 Investment in major overhaul needed in next year $55,000 Salvage value in 8 years $15,000 $90,000 Remaining life 8 years 8 years Net cash flow generated each year $30,425 $43,900 Answers that Bartebly provided is down below. My Question: Can you provide in detail what the pay back period is for the Old and New Backhoes.
- The following information is available to use in deciding whether to purchase the new backhoes or old backhoes. Using the 8% Present Value of an Annuity of 1.
|
Old Backhoes |
New Backhoes |
||
|
Purchase cost when new |
$90,000 |
$200,000 |
|
|
Salvage value now |
$42,000 |
||
|
Investment in major overhaul needed in next year |
$55,000 |
||
|
Salvage value in 8 years |
$15,000 |
$90,000 |
|
|
Remaining life |
8 years |
8 years |
|
|
Net cash flow generated each year |
$30,425 |
$43,900 |
Answers that Bartebly provided is down below.
My Question: Can you provide in detail what the pay back period is for the Old and New Backhoes. For the calculations that are already presented. Thank you
Meaning of Profitability Index :-
Profitability Index is a capital budgeting tool used to rank projects on the basis of their profitability. It is calculated by dividing the present value of all cash inflows by the initial investment. Projects with higher profitability index are better.
Formula for Profitability Index :-
| Profitability Index = | P.V of |
| Initial Investment |
Since NPV equals the PV cash inflows minus PV of Cash Outflows, we can write the present value of future value as the sum of
| Profitability Index = | Initial Investment + NPV |
| Initial Investment |
= 1 + (NPV/ Initial Investment)
Old Backhoes
Present Value of
| Year | Cash Inflows | PV Factor @8% | Present Value |
| 1 | 30425 | 0.926 | 28174 |
| 2 | 30425 | 0.857 | 26074 |
| 3 | 30425 | 0.794 | 24157 |
| 4 | 30425 | 0.735 | 22362 |
| 5 | 30425 | 0.681 | 20719 |
| 6 | 30425 | 0.63 | 19168 |
| 7 | 30425 | 0.583 | 17738 |
| 8 | 30425 | 0.54 | 16430 |
| 8 | 15000 | 0.54 | 8100 |
P.V of Cash Inflow (Total) 182922
In 8th year we will also receive salvage Value of $15000.
|
Year |
Amount (col2) |
PV factor of 8% (col3) |
Present Value(col2*col3) |
|
0 |
90,000 |
1 |
90,000 |
|
1 |
55,000 |
1/1.08 =.926 |
50,930 |
|
|
|
PV OF |
140,930 |
Therefore, NPV = 182,922 - 140,930 = 41,992.
Initial Investment = 90,000
Therefore Profitability Index = 1+ 41992/90000 = 1.47 ( rounded off)
New Backhoes
Initial Investment = $ 200,000
PV of Cash Inflow
|
Year |
Inflow Amount (col2) |
PV factor of 8% (col3) |
Present Value(col2*col3) |
|
1 |
43,900 |
1/1.08 = 0.926 |
40651 |
|
2 |
43,900 |
1/(1.08)2 = 0.857 |
37622 |
|
3 |
43,900 |
1/(1.08)3 = 0.794 |
34857 |
|
4 |
43,900 |
0.735 |
32267 |
|
5 |
43,900 |
0.681 |
29896 |
|
6 |
43,900 |
0.630 |
27657 |
|
7 |
43,900 |
0.583 |
25594 |
|
8 |
43,900 |
0.540 |
23706 |
|
9 |
90,000 (Salvage Value) |
0.540 |
48600 |
|
|
|
PV OF INFLOW |
300,850 |
In 8th year we will also receive salvage Value of $90,000.
NPV = 300,850 - 200,000 = 100,850
Therefore Profitability Index = 1+ 100850/200000 = 1.50 ( rounded off)
Conclusion :- Since the Profitability Index of New Backhoes is higher than that of Old Backhoes ..It is better to go with New Backhoes.
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