Problem 1: Mason is responsible for buying some specialized equipment for his co
ID: 1153325 • Letter: P
Question
Problem 1: Mason is responsible for buying some specialized equipment for his company. The equipment has an initial cost of $10,000 and annual operating costs of $1000. For the first four years there will be no maintenance costs. However, in years 5 through 10 the maintenance cost will be $500. Additionally, the equipment will need to be recalibrated in year five, which will cost $2000. The salvage value of the equipment in year 10 (just after the annual operating costs and maintenance costs are paid) is $1000. Determine the present value of the equipment. Assume an interest rate of 8%.
Explanation / Answer
Working notes:
(i) Annual total cost (TC) = Operating cost + Maintenance cost = $1,000 + Maintenance cost
(ii) TC, year 0 = $10,000
(iii) TC, year 5 = $1,000 + Maintenance cost + $2,000 = $3,000 + Maintenance cost
(iv) TC, year 10 = $1,000 + Maintenance cost - $1,000 (Salvage value) = Maintenance cost
(v) PV Factor in year N = (1.08)-N
Present Value of costs for the equipment is computed as follows.
Year Maintenance Cost ($) TC ($) PV factor @8% Discounted TC ($) (A) (B) (A) x (B) 0 10,000 1.0000 10,000 1 1,000 0.9259 926 2 1,000 0.8573 857 3 1,000 0.7938 794 4 1,000 0.7350 735 5 2,500 3,500 0.6806 2,382 6 500 1,500 0.6302 945 7 500 1,500 0.5835 875 8 500 1,500 0.5403 810 9 500 1,500 0.5002 750 10 500 500 0.4632 232 PV of Costs ($) = 19,307