Uncertain Future Cash Flows Hanover Industries is investigating the purchase of
ID: 2392825 • Letter: U
Question
Uncertain Future Cash Flows
Hanover Industries is investigating the purchase of automated equipment that would save $100,000 each year in direct labour and inventory carrying costs. This equipment costs $750,000 and is expected to have a 10-year useful life with no salvage value. The company requires a minimum 15% rate of return on all equipment purchases. This equipment would provide intangible benefits (such as greater flexibility and higher-quality output) that are difficult to estimate and yet are quite significant.
Required:
(Ignore income taxes.)
What dollar value per year would the intangible benefits have to be worth in order to make the equipment an acceptable investment?
Explanation / Answer
The annual value of the intangible benefits would have to be large enough to offset the $248,100 negative present value for the equipment. This annual value can be computed as follows:
NPV/10 year, 15% annuity factor:
$248,100/5.019 = $49,432
Item Year(s) Amount of Cash Flows 15% Factor Present Value of Cash Flows Cost of the equipment Now $(750,000) 1.000 $(750,000) Annual cost savings 1-10 $100,000 5.019 $501,900 Net present value $(248,100)Related Questions
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