Lukow Products is investigating the purchase of a piece of automated equipment that will save $140,000 each year in direct labor and inventory carrying costs.

Lukow Products is investigating the purchase of a piece of automated equipment that will save $140,000 each year in direct labor and inventory carrying costs. This equipment costs $850,000 and is expected to have a 5-year useful life with no salvage value. The company’s required rate of return is 10% 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.

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 $850,000 investment? (Do not round intermediate calculations. Round your answer to the nearest whole dollar amount.)

Explanation

1.

The equipment’s net present value without considering the intangible benefits would be:

Item	Year(s)	Amount of Cash Flows			10% Factor	Present Value of Cash Flows
Cost of the equipment	Now	$	(850,000	)	1.000	$	(850,000	)
Annual cost savings	1-5	$	140,000		3.791		530,740
Net present value						$	(319,260	)

2.

The annual value of the intangible benefits would have to be great enough to offset a $319,260 negative present value for the equipment. This annual value can be computed as follows:

Required increase in present value	=	$319,260	= $84,215
Factor for 5 years		3.791

Thanks