Question

Lukow Products is investigating the purchase of a piece of automated equipment that will save $160,000 each year in direct labor and inventory carrying costs. This equipment costs $870,000 and is expected to have a 7-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 8B-1 and Exhibit 8B-2, to determine the appropriate discount factor(s) using table.

Required:

What dollar value per year would these intangible benefits have to have to make the equipment an acceptable investment? (Round discount factor(s) to 3 decimal places.)

Answer 1

For making the equipment an acceptable investment, the present value of total annual cash inflows from the equipment over 7 years should be equal to or more than the cost of the equipment (i.e. $870,000) discounted at 9%.

Required minimum total annual cash inflows = Cost of Equipment/PVAF(9%, 7 yrs)

= $870,000/5.033 = $172,859

Value of intangible benefits = Required total cash inflows - Saving in cost

= $172,859 - $160,000 = $12,859

Therefore, the value of these intangible benefits have to be $12,859 or more to make the equipment an acceptable investment.