Lukow Products is investigating the purchase of a piece of automated equipment t

Question

Lukow Products is investigating the purchase of a piece of automated equipment that will save $140,000 each year in direct labor and inventory carrying costs. This equipment costs $790,000 and is expected to have a 7-year useful life with no salvage value. The company’s required rate of return is 11% on all equipment purchases. Management anticipates that this equipment will provide intangible benefits such as greater flexibility and higher-quality output that will result in additional future cash inflows.

Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using table.

What dollar value per year would these intangible benefits have to have to make the equipment an acceptable investment? (Use the tables to determine the discount rate.)

Lukow Products is investigating the purchase of a piece of automated equipment that will save $140,000 each year in direct labor and inventory carrying costs. This equipment costs $790,000 and is expected to have a 7-year useful life with no salvage value. The company’s required rate of return is 11% on all equipment purchases. Management anticipates that this equipment will provide intangible benefits such as greater flexibility and higher-quality output that will result in additional future cash inflows.

Explanation / Answer

Net present value of the investment = Present value of annual cost savings - Initial investment

Present value of annual cost savings at a discount rate of 11% for 7 years = $ 140,000 x 4.712 = $ 659,680

Net present value =$ 659,680 - $ 790,000 = $ ( 130,320)

As of now, it is not an acceptable investment. However, if there are intangible benefits leading to future cash inflows of at least $ 130,320 during the life of the asset, it might turn into an acceptable investment proposal. If the dollar value of the intangible benefits per year is V, then, 4.712V = 130,320, and V is $ 27,657

Therefore, these intangible benefits would need to have a dollar value of at least $ 27,657 per year to make the equipment an acceptable investment.

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