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Exercise 12-4 Uncertain Future Cash Flows [LO12-4] Lukow Products is investigating the purchase of a piece...

Exercise 12-4 Uncertain Future Cash Flows [LO12-4]

Lukow Products is investigating the purchase of a piece of automated equipment that will save $150,000 each year in direct labor and inventory carrying costs. This equipment costs $860,000 and is expected to have a 6-year useful life with no salvage value. The company’s required rate of return is 14% 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 12B-1 and Exhibit 12B-2, to determine the appropriate discount factor(s) using table.

Required:

1. What is the net present value of the piece of equipment before considering its intangible benefits? (Enter negative amount with a minus sign. Round your final answer to the nearest whole dollar amount.)

2. What minimum dollar value per year must be provided by the equipment’s intangible benefits to justify the $860,000 investment? (Do not round intermediate calculations. Round your answer to the nearest whole dollar amount.)

1. Net present value
2. Minimum dollar value

Exercise 12-5 Preference Ranking [LO12-5]

Information on four investment proposals is given below:

Investment Proposal
A B C D
Investment required $ (300,000 ) $ (140,000 ) $ (100,000 ) $ (1,500,000 )
Present value of cash inflows 424,800 191,700 151,100 2,001,700
Net present value $ 124,800 $ 51,700 $ 51,100 $ 501,700
Life of the project 5 years 7 years 6 years 6 years

Required:

1. Compute the project profitability index for each investment proposal. (Round your answers to 2 decimal places.)

2. Rank the proposals in terms of preference.

Investment Proposal Project Profitability Index Rank Preference
A
B
C
D

Homework Answers

Answer #1
1
Annual cost savings 150000
Multiplied by 12% Factor 3.889
Present value of Annual cost savings 583350
Less: Cost of the equipment 860000
Net present value (276650)
2
Amount of intangible benefits = Required increase in present value/Factor for 8 years
Minimum dollar value = 276650/3.889= $71137
Exercise 12-5
Profitability Index = Net present value/Investment required
Investment Proposal Profitability Index Rank Preference
A 0.42 Second =124800/300000
B 0.37 Third =51700/140000
C 0.51 First =51100/100000
D 0.33 Fourth =501700/1500000
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