Jannsen Limited is investigating the purchase of solar panels that would save $100,000 each year in electricity costs. This solar panels cost $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 solar panels an acceptable investment?

For an investment becomes acceptable the net present value generating from that investments should be positive. That means present value of cash in flows should be equal to present value of cash outflows.

(Net present value= Present value of cash inflows- Present value of cash outflows)

Present value of cash savings from electricity costs for 10 Years= Annual savings from electricity cost* Present value annuity factor for 10 Years at 15% discounting rate (Required rate of return is 155 and it will be used as discounting rate)

= $100000* 5.0188= $501880

Present value of cash outflows= Initial investment= $750000

Present value of cash inflows from intangible benefits for 10 Years needed to meet present value of cash outflows= Initial investment- Present value of cash savings from electricity costs for 10 Years= 750000- 501880= $248120

To create a positive net present value present value of cash inflows should be greater than outflows.

$248120= Annual cash inflow from intangible benefits* Present value annuity factor for 10 Years at 15% discounting rate

= Annual cash inflow from intangible benefits* 5.0188

Annual cash inflow from intangible benefits= $248120/ 5.0188= $49439

In order to make the solar panels an acceptable investment the dollar value per year would the intangible benefits have to be worth any amount higher than $49439.

(When NPV becomes zero the project would be indifferent. The project can be accepted or rejected. If NPV is positive project can be accepted. Any amount greater than $49439 will create a positive NPV)