Eddie\'s Precision Machine Shop is insured for $700,000. The present yearly insu

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 so salvage value can be installed for $20,000. Annual maintenance costs for the sprinkler system are $400. If the sprinkler system is installed, the system must be coverage. Eddie uses a MARR of percent/year. a. What is the annual worth of this investment? b. What is the decision rule for judging the attractiveness of investments based on annual worth? c. Is the sprinkler system economically justified?

Explanation / Answer

a. cost of the insurance without the sprinkler system = $700,000/100 X $1 $7,000 per year cost of the insurance with the sprinkler system = ($700,000 + $20,000)/100 x $.40 $2,880 Per year Savings on Insurance premium ($7000 - $2880) $4,120 Annual Maintenance cost of Sprinkler $400 Savings on Insurance premium($4120 - $400) $3,720 per year So the sprinkler system saves you $4,120 per year but costs you $20,000 to install and $400 a year for 20 years. Year Net Cash flows PV @ 12% Present Value 0 -$20,000 1.0000 -$20,000 1 $3,720 0.8929 $3,321.43 2 $3,720 0.7972 $2,965.56 3 $3,720 0.7118 $2,647.82 4 $3,720 0.6355 $2,364.13 5 $3,720 0.5674 $2,110.83 6 $3,720 0.5066 $1,884.67 7 $3,720 0.4523 $1,682.74 8 $3,720 0.4039 $1,502.45 9 $3,720 0.3606 $1,341.47 10 $3,720 0.3220 $1,197.74 11 $3,720 0.2875 $1,069.41 12 $3,720 0.2567 $954.83 13 $3,720 0.2292 $852.53 14 $3,720 0.2046 $761.19 15 $3,720 0.1827 $679.63 16 $3,720 0.1631 $606.81 17 $3,720 0.1456 $541.8 18 $3,720 0.1300 $483.75 19 $3,720 0.1161 $431.92 20 $3,720 0.1037 $385.64 Annual Worth $7,786.33 b. Investment is attractive as its NPV is positive at the discount rate of 12% c. Yes, It is Justified as the benefits exceed the costs.

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