Question

A company would like to purchase a machine for $200,000 with a life of 11 years. They estimate the salvage value to be 6% of the initial machine cost. If other operating costs are estimated to be $30,000 per year. The interest rate the company uses to justify their investments is 5% per year compounded yearly.

a. What is the capital recovery cost?
b. What is the minimum amount of annual revenue ($? per year) that makes this investment an attractive option for the company?

Answer 1

a)

Initial Cost=I=$200,000

Salvage=S=200000*6%=$12000

Useful life=n=11 years

Rate of interest=i=5%

Capital Recovery cost=(I-S)*(A/P,i,n)+S*i

Capital Recovery cost=(200000-12000)*(A/P,0.05,11)+12000*5%

Let us calculate the interest factor

So,

Capital Recovery cost=-[(200000-12000)*0.120389+12000*5%]=$23233.13

(its a cost. So, it is negative)

b)

Operating cosr per year=OC=$30000

Let the minimum revenue per year be X

AW of project=+CR+OC+Revenue per year=-23233.13-30000+X

Project is acceptable if AW is at least 0

So,

-23233.13-30000+X=0

X=$53,233.13