Question

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

Answer 1

If Company have net benefits of $22,000 each year then finding present worth of these net benefits discounting with 5% for next 5 years

It is as good as invesing a capital at 5% interest rate that will yield 22000 each year hence forth

22000/(1.05)+22000/(1.05)^2+22000/(1.05)^3+22000/(1.05)^4+22000/(1.05)^5=X

X is the value of Machine or boudary value of machine beyond which company will not be able to earn more than 5%

22000*4.33=$95260

Hence If Machine Cost more than this Company should not opt to buy a machine otherwise buy to earn more than 5% when price of machine less than $95260