Question

# 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

 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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