Question

Lukow Products is investigating the purchase of a piece of automated equipment that will save $400,000 each year in direct labor and inventory carrying costs. This equipment costs $2,500,000 and is expected to have a 15-year useful life with no salvage value. The company’s required rate of return is 20% 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:What dollar value per year would these intangible benefits have to have to make the equipment an acceptable investment?

Answer 1

Answer:

The intangible benefits will be required to have a value of $ 100 000.

Explanation:

To calculate the return on the equipment (ROI) we consider the profit/saving it contributes over the cost of the equipment.

Currently we have a save to costs of $400000 (increases revenue) and a cost of $2500000.

Our current return on the asset is 400/2500 * 100 which equates to 16%.

Management requires a rate of return of 20% thus the intangible benefits need to make up 4%

we can determine the dollar value by determining 20% of the cost of equipment. 2500 * 20% = 500 ( using thousands, $ ' 000)

500 - 400 = 100.

The value of the intangible assets will be required to be $ 100 000.

If we add this into the ROI formula we now have 500 / 2500 * 100 = 20%.

Thus management's requirement is now met