Question

You are considering investing $65,000 in new equipment. You estimate that the net cash flows will be $18,000 the first year, but will increase by $2,500 per year the next year and each year thereafter.The equipment is estimated to have a 10-year service life and a net salvage value of $5,000 at that time Assume an interest rate of 9%.
(a) Determine the annual capital cost (ownership cost) for the equipment.
(b) Determine the equivalent annual savings (revenues)
(c) Determine whether this is a wise investment.

Answer 1

Answer:

a. The annual capital cost is $9,798

b. The equivalent annual savings is $27,495

c. The decision is wise

Explanation:

a. In order to calculate the annual capital cost (ownership cost) for the equipment we would have to calculate the following formula:

annual capital cost=P(A/P,i,n)-F(A/F,i,n).........

annual capital cost=$65,000(A/P,9%,10)-$5,000(A/F,9%,10)

=$65,000(0.1558)-$5,000(0.0658)

=$10,127-$329

=$9,798

b. In order to calculate the equivalent annual savings (revenues) we would have to calculate the following formula:

equivalent annual savings=A+G(A/G,i,n).........

equivalent annual savings=$18,000+$2,500(A/G,9%,10)

=$18,000+$2,500(3.798)

=$18,000+$9,495

=$27,495

c. The decision is wise becauste the equivalent annual savings are greater than the annual costs of the equipment.