Lukow Products is investigating the purchase of a piece of automated equipment t
ID: 2763397 • Letter: L
Question
Lukow Products is investigating the purchase of a piece of automated equipment that will save $120,000 each year in direct labor and inventory carrying costs. This equipment costs $770,000 and is expected to have a 5-year useful life with no salvage value. The company’s required rate of return is 9% 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 $120,000 each year in direct labor and inventory carrying costs. This equipment costs $770,000 and is expected to have a 5-year useful life with no salvage value. The company’s required rate of return is 9% 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
NPV of the investment = $ 120,000 x 3.8897 - $ 770,000 = $ ( 303,236)
As NPV is negative, the investment is not acceptable as it is.
The minimum dollar value per year of intangible benefits to make the investment acceptable = $ 770,000 / 3.8897 = $ 198,000
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