Question

Exercise 13-4 Uncertain Future Cash Flows [LO13-4]

Lukow Products is investigating the purchase of a piece of automated equipment that will save $100,000 each year in direct labor and inventory carrying costs. This equipment costs $890,000 and is expected to have a 6-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 13B-1 and Exhibit 13B-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 $890,000 investment? (Do not round intermediate calculations. Round your answer to the nearest whole dollar amount.)

Answer 1

1
Annual cash flows	100000
X PV factor of $1 annuity	4.486	=(1-(1.09)^-6)/0.09
Present value of Annual cash flows	448600
Less: Investment cost	890000
Net present value	-441400
2
Negative Net present value to offset	441400
Divide by PV factor of $1 annuity	4.486
Minimum dollar value	98395	or 98399