A small manufacturing company is considering purchasing a maintenance contract f

Question

A small manufacturing company is considering purchasing a maintenance contract for its air conditioning systems. Since all of its systems are new, the company plans to begin the contract in year four and continue through year ten. The cost of the contract is $3,200 per year and the company's minimum attractive rate of return is 12% per year.

A) what is present worth of the contract?

B)if the company wishes to pre-pay the contract with uniform payment in years one, two, and three only, what is the amount of each payment?

C) what is the equivalent uniform annual amount of the contract in years one through ten?

Explanation / Answer

(A)

In year 4, Present Worth (PW) = $3,200 x P/A(12%, 6 years)

= $3,200 x 4.11 = $13,152

PW of this amount in year 0 = $13,152 x P/F(12%, 4 years)

= $13,152 x 0.64

= $8,417.28

(B)

If the annual payment be M,

$8,417.28 = M x P/A(12%, 3 years)

$8,417.28 = M x 2.4

M = $8,417.28 / 2.4 = $3,507.20

(C)

EUA of contract = $8,417.28 x A/P**(12%, 10 years)

= $8,417.28 x 0.18

= $1,515.11

** A/P(r%, N years) is Capital Recovery Factor.

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