5. (12 pts) On your internship, you are asked to evaluate a possible major maint

Question

5. (12 pts) On your internship, you are asked to evaluate a possible major maintenance project on part of your assembly line. The savings the first year are projected to be $25,000 and the savings is expected to decrease 4% every year after that. To pay for this project, money will be withdrawn from an investment paying 6.5% annual interest compounded annually. The life of this assembly line is 6 years. Recommend to your boss the maximum the company should be willing to pay for this major maintenance project.

Explanation / Answer

Year Annual savings 1 25000 2 24000 =25000*(1-4%) 3 23040 =24000*(1-4%) 4 22118.4 =23040*(1-4%) 5 21233.66 =22118.4*(1-4%) 6 20384.31 =21233.66*(1-4%) The maximum amount to be paid can be determined by discounting the annual savings at 6.5% interest rate Year Annual savings PV factor @ 6.5% Present value 1 25000 0.93897 23474.18 2 24000 0.88166 21159.82 3 23040 0.82785 19073.64 4 22118.4 0.77732 17193.14 5 21233.66 0.72988 15498.04 6 20384.31 0.68533 13970.07 Total 110368.90 The maximum amount company should be willing to pay for this maintenance project is $110368.90 Note: The final answer might vary slightly due to rounding off

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