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 $130,000 each year in direct labor and inventory carrying costs. This equipment costs $780,000 and is expected to have a 6-year useful life with no salvage value. The company's required rate of return is 10% 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 factors) using table. Required: 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.)

Explanation / Answer

To calculate the dollar value per year of the intangible benefits first we have to calculate the present value of the benefits.

Now investment amount is $780,000

Useful life is 6 years

Rate is 10%

Savings each year is of $130,000

So PV of the savings each year is $130,000* 6years PV factor

= $130,000*4.355 = $566,150

So $566,150 out of $780,000 is covered from savings.

Remaining amount is $213,850 which is the PV as on date

So Annual value of intangibles is $213,850/ PV Factor of 6 years at 10%

= $213,850 / 4.355 = $49,104

So annual value of intangible benefits should be $49,104

Total per year saving should be $49,104 and $130,000 to cover the investment.

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