Aerotron Electronics is considering purchasing a water filtration system to assi
ID: 2740768 • Letter: A
Question
Aerotron Electronics is considering purchasing a water filtration system to assist in circuit board manufacturing. The system costs $38,000. It has an expected life of 7 years at which time its salvage value will be $5,500. Operating and maintenance expenses are estimated to be $2,000 per year. If the filtration system is not purchased, Aerotron Electronics will have to pay Bay City $13,000 per year for water purification. If the system is purchased, no water purification from Bay City will be needed. Aerotron Electronics must borrow 1/2 of the purchase price, but they cannot start repaying the loan for 2 years. The bank has agreed to 3 equal annual payments, with the 1st payment due at the end of year 2. The loan interest rate is 8.5 % compounded annually. Aerotron Electronics’ MARR is 12.0 % compounded annually.
What is the present worth of this investment?
Explanation / Answer
All amounts are in $ terms
Calculation of present worth of the investment
Year
Particulars
Cash Flow
Present value factor @12%
Discounted Cash Flow
0
Purchase of System
(38,000)
1
(38,000)
0
Borrowing
19,000
1
19,000
1-7
Operating cost
(2,000)
4.5638
(9,127.60)
1-7
Savings in water purification charges
13,000
4.5638
59,329.40
3-5
Loan Repayment
(8,757.78)
1.9147
(16,768.52)
7
Salvage Value
5,500
0.4523
2,487.65
Present Worth of the Investment
16,920.93
Note: Depreciation has not been considered as it has not been mention specifically in the given question.
Loan Schedule
Year
Opening Balance
Instalment
Interest @8.5%
Principal
Closing Balance
1
19,000
0
1,615
0
20,615
2
20,615
0
1,752.28
0
22,367.28
3
22,367.28
8,757.78
1,901.22
6,856.56
15,510.72
4
15,510.72
8,757.78
1,318.41
7,439.37
8,071.35
5
8,071.35
8,757.78
686.43
8071.35
0
Note: Instalment = Loan Amount/PVAF (8.5%, 3-5yrs) = 19,000/2.1695 = 8,757.78
Year
Particulars
Cash Flow
Present value factor @12%
Discounted Cash Flow
0
Purchase of System
(38,000)
1
(38,000)
0
Borrowing
19,000
1
19,000
1-7
Operating cost
(2,000)
4.5638
(9,127.60)
1-7
Savings in water purification charges
13,000
4.5638
59,329.40
3-5
Loan Repayment
(8,757.78)
1.9147
(16,768.52)
7
Salvage Value
5,500
0.4523
2,487.65
Present Worth of the Investment
16,920.93
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