Eddie’s Precision Machine Shop is insured for $700,000. The present yearly insur
ID: 1190362 • Letter: E
Question
Eddie’s Precision Machine Shop is insured for $700,000. The present yearly insurance premium is $1.00 per $100 of coverage. A sprinkler system with an estimated life of 20 years and no salvage value can be installed for $50,000. Annual maintenance costs for the sprinkler system are $3,700. If the sprinkler system is installed, the system must be included in the shop’s value for insurance purposes, but the insurance premium will reduce to $0.40 per $100 of coverage. Eddie uses a MARR of 15%/year. a. What is the annual worth of this investment? b. Is the filter economically justified?
Explanation / Answer
a. Annual premium without the sprinkler = 700000 * 1/100 = $7,000
Annual premium with sprinkler =750000*0.4/100 = $3,000
Thus, Annual savings from sprinkler = $7000 - 3000 = $4,000
Net benefits = Savings - annual costs = 4000 - 3700 = $300
Thus, Cashflows are -50000 at year 0 and $300 from years 1 to 20.
b.
The total worth of this investment = -50000 + Present value of $300 per year for 20 years at 15% p.a
= -50000 + PV(15%,20,-300) = -50000 + 1877.80 = -48,122.20
Thus, the sprinkler is not economically justified.
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