A service agreement could be selected to keep the new unit, machine Brooks ARX-1

ID: 1140850 • Letter: A

Question

A service agreement could be selected to keep the new unit, machine Brooks ARX-100, in good standing. Historical data show us that maintenance cost will be $2,300 for the first year and will increase by $400 for each year. The machine is to be in service for 10 year and require a major repair with a cost of $1,850 at the midpoint of its life. The interest rate available is 10%. Determine the amount today for the service agreement that will be required from the seller of the agreement.

(Please show Cash flow, Procedure, and the Result)

Explanation / Answer

Midpoint of 10 year life is 5.5 years, which falls under 6th year. Therefore, the major repairing cost ($1,850) should fall under 6th year.

There should be a calculation of present value (PV) for finding the amount of service agreement.

Cash flows and supporting procedure are as below:

Year

Cash flow, CF

10% factor (F) = 1 / (1 + 0.10) ^ year

CF × F

-2,300

1/1.10^1 = 0.90909

-2090.907

2,300 + 400 = -2,700

1/1.10^2 = 0.82644

-2231.388

2,700 + 400 = -3,100

0.75131

--2329.061

3,100 + 400 = -3,500

0.68301

-2390.535

3,500 + 400 = -3,900

0.62092

-2421.588

3,900 + 400 + 1,850 = -6150

0.56447

-3471.491

6,150 + 400 = -6,550

0.51315

-3361.133

6,550 + 400 = -6,950

0.46650

-3242.175

6,950 + 400 = -7,350

0.42409

-3117.062

7,350 + 400 = -7,750

0.38554

-2987.935

Total = -27,643.28

Note: Since there are all costs, cash flows are negative.

Answer: today’s amount is $27,643.28.