Uncertain Future Cash Flows Hanover Industries is investigat

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?

Solution

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