9. construction equipment costs $40,000 today. If the market interest rate was 1
ID: 2589417 • Letter: 9
Question
9. construction equipment costs $40,000 today. If the market interest rate was 15% per year and cost has increased only by the inflation rate of 6% per year, its cost 10 years ago was closest to: A. $71,600 B. $27,405 C. $22,335 D. $17,700 Formula used: 10. An alternative has the following cash flows: benefits $60,000 per year; disbenefits $25,000 per year annual equivalent of initial cost--$30,000: O&M; costs of $10,000 per year. year, the modified B/C ratio is closest to: At an interest rate of 10% per A. 0.89 B. 0.83 C. 0.67 D. 0.64 Formula used:Explanation / Answer
9. We are required to find the present value of $40,000 for 10 years.
Formula for present value of 10 years = 40,000 / (1+i)10
Where i is the effective annual interest rate considering inflation.
i = [(1+Market Rate) / (1+Inflation rate)] - 1
= [1.15 / 1.06] - 1 = 0.849 or 8.49%
This rate is net annual market rate after inflation factor is considered.
Now putting the same in above mention present value formula we get,
Present Value of $40,000 10 years ago = 40,000 / (1+0.849)10 = $40,000 x 0.44269 = $17,700 Approx.
Correct Answer is D.
10. Calculation of Benefit Cost Ratio
B/c ratio = Present Value of Benefits per year / Present Value of Cost per year
Total Benefits per year = $60,000 - 25,000 = $35,000
Present Value of benefits for one year = 35,000 / (1+i)1 = 35,000 / (1+10%)1 = 35,000 x .909 = $31,815
Total Cost per year = $30,000 + 10,000 = $40,000
Present Value of benefits for one year = 35,000 / (1+i)1 = 40,000 / (1+10%)1 = 40,000 x .909 = $36,360
B/C Ratio = 31,815 / 36,360 = 0.875 which is closest to 0.89
Correct answer is A.
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