Question

The maintenance expense (paid at the end of the year) on a machine, with 6 years of useful life, is expected to be (in constant dollars of year 0) $5,000 during the first year and to increase (in constant dollars) $500 each year for the following five years. The average inflation rate for the next 6 years is calculated to be 3%. What is the equivalent equal annual maintenance cost (in actual dollars) for the machinery if the interest rate is 8%

Answer 1

Answer: $1387.5

Explanation:

Given data:

Useful life of the machine = 6years

Inflation for the 6years period = 3%

Interest rate = 8%.

Cost of maintenance = $5000

Yearly increments = $500 for five years.

Solution:

Total cost of maintenance for five years

= cost of maintenance + yearly increments x 5

= $5000 + $500(5)

= $5000 + $2500

= $7500.

Interest rate on the machinery = 8%

= 0.08 x $7500

= $600

Inflation rate

= 0.03 x 7500

= $225

Equal yearly maintenance cost

= $7500 + $600 + $225/ 6

= $8325/6

= $1387.5