Question

Pace Corporation in Cookeville is considering an extended warranty on production equipment it bought recently. The extended warranty will cover repair year-end expenses of $2,000, $2,000, $4,000, and $5,000, respectively, for the next 4 years. If the interest rate is 6%, what is the worth of the extended warranty

Answer 1

Answer:

$10,985.73

Explanation:

The worth of the extended warranty in today's terms is the present value of all year-end repair expenses expected to be incurred in extending the warranty whereby the interest rate of 6% is the appropriate discount rate in this case as shown thus:

Present value of a future cash flow=cash flow/(1+discount rate)^n

n is the year in which the cash flow is expected, it is 1 for year 1 repair expenses , 2 for year 2 and so on.

PV of repair expenses=$2000/(1+6%)^1+$2000/(1+6%)^2+$4000/(1+6%)^3+$5000/(1+6%)^4

PV of repair expenses= $10,985.73