Question

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

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