Uba Plastics is investigating the purchase of automated equipment that would sav

Question

Uba Plastics is investigating the purchase of automated equipment that would save $50,000 each year in direct labor and inventory carrying costs. This equipment costs $375,000 and is expected to have a 10-year useful lift with no salvage value. The company’s required rate of return is 30% on all equipment purchases. This equipment would provide intangible benefits such as greater flexibility and higher-quality output that are difficult to estimate and yet are quite significant.

(Ignore income taxes)

What dollar value per year would the intangible benefits have to have in order to make the equipment an acceptable investment?

Explanation / Answer

Initial investment = 375000

Required return = .30 * 375000 = $ 112500 per year

Tangible benfit = 50000

Return = [Tangible benefit +intangible benefit ]

112500 = [50000 +X ]

X = 112500 -50000

= 62500

Intangible benefit required per year = 62500

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