Lukow Products is investigating the purchase of a piece of automated equipment t
ID: 2484463 • Letter: L
Question
Lukow Products is investigating the purchase of a piece of automated equipment that will save $100,000 each year in direct labor and inventory carrying costs. This equipment costs $810,000 and is expected to have a 6-year useful life with no salvage value. The company’s required rate of return is 7% 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 $100,000 each year in direct labor and inventory carrying costs. This equipment costs $810,000 and is expected to have a 6-year useful life with no salvage value. The company’s required rate of return is 7% 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
The details given as per problem
The value of investment is $8,10,000
The life period is 6 years
The savings is $100,000 every year for six years
The cost of capital is 7%
Let us calculate the PW of the project
Present value If $1 is received annually for 6 years at 7% is 4.7665
We have calculate the annual cash flows at PV factor of 4.7665 should be equal to investment in formula terms it will be
Annual cash flow x 4.7665 = initial investment
Annual cash flow x 4.7665 = 810,000
Annual cash flow = 810,000 / 4.7665
Annual cash flow = 169,936
Thus the dollar value per year of the intangible benefits must be worth at least:
Annual cash inflows required
$169,936
Less known yearly savings
100,000.
Minimum yearly intangible benefits
$69,936
the intangible benefits should be $ 69,936 per year to make the equipment acceptable
Thus the dollar value per year of the intangible benefits must be worth at least:
Annual cash inflows required
$169,936
Less known yearly savings
100,000.
Minimum yearly intangible benefits
$69,936
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