(Ignore income taxes in this problem.) The management of Bischke Corporation is investigating an investment in equipment that would have a useful life of 8 years. The company uses a discount rate of 16% in its capital budgeting. Good estimates are available for the initial investment and the annual cash operating outflows, but not for the annual cash inflows and the salvage value of the equipment. The net present value of the initial investment and the annual cash outflows is -$238,486.
-Ignoring the cash inflows, 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?

Question

Quizplus · Accepted Answer

To find the salvage value that would make the investment financially attractive, we need to calculate the present value of the salvage value using the discount rate of 16% and then add it to the net present value of the initial investment and the annual cash outflows. This total should be zero or positive for the investment to be financially attractive.

Let SV be the salvage value of the equipment. Then, the present value of SV is:

PV(SV) = SV / (1 + r)^n
where r is the discount rate (16%) and n is the number of years until the salvage value is received (8).

PV(SV) = SV / (1 + 0.16)^8

PV(SV) = 0.3409SV

Adding PV(SV) to -$238,486 gives:

0.3409SV - $238,486 ≥ 0

0.3409SV ≥ $238,486

SV ≥ $781,921

Therefore, the salvage value would have to be at least $781,921 to make the investment in the equipment financially attractive. The correct answer is B).

(Ignore Income Taxes in This Problem