Croce, Incorporated, is investigating an investment in equipment that would have a useful life of 7 years. The company uses a discount rate of 8% in its capital budgeting. The net present value of the investment, excluding the salvage value, is −$515,967. To the nearest whole dollar how large would the salvage value of the equipment have to be to make the investment in the equipment financially attractive? (Ignore income taxes.)Click here to view Exhibit 14B-1 and Exhibit 14B-2, to determine the appropriate discount factor(s) using the tables provided.

Question

Quizplus · Accepted Answer

The salvage value is the amount that would be received at the end of the 7 year useful life, so it needs to be discounted back to its present value using the same 8% discount rate. We can use the net present value formula to solve for the salvage value.

NPV = PV of cash inflows - PV of cash outflows

We know that the NPV is currently -$515,967 and there are no cash inflows, so the only cash outflow is the initial investment in the equipment. Let's call the salvage value "S" and the initial investment "I". The cash outflow would be:

PV of cash outflow = -I + PV of salvage value = -I + S / (1 + r)^n

where r = discount rate = 8%
and n = number of years = 7

Plugging in the given values, we get:

-$515,967 = -I + S / (1 + 0.08)^7
-$515,967 = -I + S / 1.7138
-$515,967 = -I + 0.5832S
0.5832S = -$515,967 + I

We don't know the initial investment "I", but we do know that it is negative and is subtracted from the salvage value, so we can set an upper bound for S by assuming I = 0. This would mean the salvage value would need to be at least $515,967 in order to have a net present value of zero.

0.5832S = -$515,967
S = -$515,967 / 0.5832
S = $885,021 (rounded to the nearest dollar)

Therefore, the salvage value would need to be at least $885,021 to make the investment financially attractive. Choice B is the correct answer.

Croce, Incorporated, Is Investigating an Investment in Equipment That Would