Question

2. Hood Company owns specialized equipment that was purchased in an acquisition of Riding Company. The equipment has a book value of $1,800,000, but according to IFRS, it is assessed for impairment on an annual basis. To perform this impairment test, Hood must estimate the fair value of the equipment. It has developed the following cash flow estimates related to the equipment based on internal information. Each cash flow estimate reflects Hood's estimate of annual cash flows over the next 7 years. The equipment is assumed to have no residual value after the 7 years. (Assume the cash flows occur at the end of each year.) Year Cash Flow Estimate 1–3 $240,000 4–6 365,000 7 425,000 Hood determines, using their own assumptions, that the appropriate discount rate for this estimation is 6%. To the nearest dollar, what is the estimated fair value of the equipment?

Answer 1

Let's calculate the NPV of the equipment with discount rate of 6%

	Fair Value of Equipment
		1	2	3	4	5	6	7
Particulars	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7	Total
Units Sales Projection		9,000	15,000	18,000	22,000	22,000	22,000
Sales Price p.u.		$           35	$           35	$           35	$           35	$           35	$           35
Initial Investment		$ 240,000	$ 240,000	$ 240,000	$ 365,000	$ 365,000	$ 365,000	$ 425,000
Discount Rate	6%	6%	6%	6%	6%	6%	6%	6%
DCF	1	$0.943	$0.890	$0.840	$0.792	$0.747	$0.705	$0.665
PV @ 6%	-	226,415	213,599	201,509	289,114	272,749	257,311	282,649	1,743,346

Based on the above, cumulative NPV of the equipment is 1,743,346 $.