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It is estimated that a certain piece of equipment can save $22,000 per year in labor...

It is estimated that a certain piece of equipment can save $22,000 per year in labor and materials costs. The equipment has an expected life of five years and no market value. If the company must earn a 5% annual return on such investments, how much could be justified now for the purchase of this piece equipment? Draw a cash-flowing diagram from the company's viewpoint

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Answer #1

Following is the required cash flow diagram -

Savings in labor and material costs per year (A) = $22,000

Interest rate (i) = 5%

Time period (n) = 5 years

The present value of the annual savings over the given time period would be the amount that is justified to be paid for the purchase of this equipment.

Calculate Present Value -

Present Value = A (P/A, i, n)

Present Value = $22,000 (P/A, 5%, 5)

Present Value = $22,000 * 4.3295

Present Value = $95,249

The company is justified to pay $95,249 now for the purchase of this piece of equipment.

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