Question

Bobo Jungle Gyms uses a discount rate of 12% in its capital budgeting. Partial analysis of an investment in automated equipment with a useful life of 8 years has thus far yielded a net present value of -$195,551. This analysis did not include any estimates of the intangible benefits of automating this process nor did it include any estimate of the salvage value of the equipment.

a. Ignoring any salvage value, how large would the additional cash flow per year from the intangible benefits have to be to make the investment in the automated equipment financially attractive?

b. Ignoring any cash flows from intangible benefits, how large would the salvage value of the automated equipment have to be to make the investment in the automated equipment financially attractive?

Answer 1

Solution a:

NPV of automated equipment = -$195,551

Discount rate = 12%

Useful life = 8 years

Required additional cash inflow from intangible benefits to make investment in equipment financially attractive =

(Difference in PV of cash outflows - PV of cash inflows) / cumulative PV factor for 8 period at 12%

= $195,551 / 4.96764 = $39,365

Solution b:

Required salvage value of the automated equipment to make the investment financially attractive =

(Difference in PV of cash outflows - PV of cash inflows) / PV factor for 8th period at 12%

$195,551 / 0.403883 = $484,177