Question

A tubing manufacturer sees an upcoming market for special alloy tubing. Its metallurgy and shape characteristics will have to ensure reliability in corrosive environments as well as heretofore unavailable flexing properties. The company is interested in producing the new tubing. What capital expenditure for design and development is justified today if they expect to have incomes of $2,000,000 per year for 7 years beginning at the end of year 4? Interest is 15%.

Carry all interim calculations to 5 decimal places and then round your final answer to 3 decimal places. Please enter your answer in millions of dollars. The tolerance is ±0.003.

Answer 1

Solution :-

The Capital expenditure for design and development is justified today =

Present Value of 7 Years of annual Income at the end of Year 3 = $2,000,000 * PVAF ( 15% , 7 )

= $2,000,000 * [ 1 - ( 1 + 0.15 )^-7 ] / 0.15

= $2,000,000 * ( 1 - 0.37594 ) / 0.15

= $2,000,000 * 4.16042

= $8,320,839.47

Now The Present Value of Income today = $8,320,839.47 / ( 1 + 0.15 )³

= $8,320,839.47 * 0.65752

= $5,471,087.017

Therefore Capital expenditure for design and development that is  justified today = $5,471,087.017

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