Ms. Lotta Money is a well-known consultant to the oil industry. One of Ms. Money
ID: 2698204 • Letter: M
Question
Ms. Lotta Money is a well-known consultant to the oil industry. One of Ms. Money’s clients is the North Atlantic Petroleum Company, Inc. North Atlantic has just purchased a piece of equipment used in off-shore oil exploration and has provided Ms. Money with the following data: (1) the purchase price for the equipment, including all setup and installation costs, is $100,000 (initial outflow); (2) at the end of the first year of operation, it is expected that $5000 will be spent on maintenance; (3) each year, the cost of maintenance is expected to increase by 15 percent (all other revenue and cost data are assumed to remain constant over the life of the equipment); (4) North Atlantic estimates that its cost of capital is 10 percent; (5) the equipment has a zero expected salvage value; and (6) the equipment has a useful economic life of 15 years and North Atlantic will operate it for at least 5 years.
North Atlantic has determined that this is a profitable project and has not asked Ms. Money to comment on this aspect of the investment. Rather, North Atlantic has requested that she determine how long the equipment should be operated before it is scrapped. As an analyst working for Ms. Money, you have been assigned to perform the analysis. What is your conclusion?
Answer: The machine should be scrapped at the end of Year 12. Please show work.
Explanation / Answer
Accounting in your city An Historical Perspective of Net Present Value and Equivalent Annual Cost Thomas W. Jones UNIVERSITY OF ARKANSAS and J. David Smith WESTERN ILLINOIS UNIVERSITY AN HISTORICAL PERSPECTIVE OF NET PRESENT VALUE AND EQUIVALENT ANNUAL COST Abstract: Net present value and equivalent annual cost are two discounted cash flow criteria for comparing investment proposals. Why have accountants taken to net present value? Why do engineers readily use equivalent annual cost? This paper investigates the historical development of these principles to provide an explanation of why this is so. Capital financing and budgeting represents a fundamental func-tion of management. In a recent paper, Truitt
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.