Question

The engineering staff at the Sun Shipping Company has informed decision-makers that substantial money can be saved on the fleet's fuel bills if the ships' engines are adapted. Based on the cost of fuel, the engineers estimate that the firm will save $50,000 each year for the first 5 years and save $75,000 per year for the following five years. If these estimates are accurate, what would the company be willing to pay to adapt the engines? The company can earn 10% annually on its investments.

Answer 1

The amount to be paid is the present value of all future cash flows receivable discounted at required rate of return

Present value factor

= 1 / (1 + r) ^ n

Where,

r = Rate of return = 10% or 0.10

n = Years = 1 to 10

So, PV Factor for year 2 will be

= 1 / (1.10^2)

= 1 / 1.21

= 0.826446

The following table shows the calculations

Calculations	Particulars
A	Years	0	1	2	3	4	5	6	7	8	9	10
B	Cash Flows		50000	50000	50000	50000	50000	75000	75000	75000	75000	75000
C	PV Factor		0.909091	0.826446	0.751315	0.683013	0.620921	0.564474	0.513158	0.466507	0.424098	0.385543
D = B x C	Present Values		45454.55	41322.31	37565.74	34150.67	31046.07	42335.54	38486.86	34988.05	31807.32	28915.75
E = Sum D	Net Present Values	366072.86

So, the amount that the company will be willing to pay for the engines is $ 366,072.86