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.

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.