Hassle-free Web is bidding to provide web hosting services for Hotel Lisbon. Hot

Question

Hassle-free Web is bidding to provide web hosting services for Hotel Lisbon. Hotel Lisbon pays its current provider $10,500 per year for hosting its web page, handling transactions, etc. Hassle free figures that it will need to purchase equipment worth $15,100 up front and then can spend $2,200 per year on monitoring, updates, and bandwidth to provide the service for 3 years. If Hassle Free's cost of capital is 10.4%, can it bid less than $10,500 per year to provide the service and still increase its value by doing so?

1. Hassle-Free can bid as low as $_________

Explanation / Answer

Initial investment = $15100

Annual maintenance cost = $2200

R = 10.4%

Time (n) = 3 years

Here, we have to calculate equivalent annual cost (EAC) .

Thus,

Present value of all investments = initial investment + Present value of annual maintenance cost

Present value of all investments = 15100 + 2200*(1-1/(1+R)^n)/R

Present value of all investments = 15100 + 2200*(1-1/(1+10.4%)^3)/10.4% = $20532.78

Now, we have to calculate EAC.

Present value of all investments = EAC*(1-1/(1+R)^n)/R

20532.78 = EAC*(1-1/(1+10.4%)^3)/10.4%

20532.78 = EAC* 2.4694

EAC = 20532.78 / 2.4694

EAC = $8314.88

Yes, Hassle-Free can bid lower than $10000 per year and can still make value.

Hassle-Free can bid as low as $8314.88 per year.

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