Lichty uses the total-cost approach and a discount rate of 12% in making capital

Question

Lichty uses the total-cost approach and a discount rate of 12% in making capital budgeting decisions. Regardless of which option is chosen, rebuild or replace, at the end of four years Mr. Lichty plans to close the car wash and retire.

$(34,926)

$(21,259)

$(19,741)

$(48,592)

Present Equipment New Equipment   Purchase cost new $84,500         $75,000           Remaining book value $23,000           Cost to rebuild now $23,000           Major maintenance at the end of 3 years $6,500         $4,500            Annual cash operating costs $16,500         $11,500            Salvage value in 4 years $5,000         $15,000            Salvage value now $20,000        

Explanation / Answer

The correct answer is $(34,926)

Calculation:

Annual Cash Operating Cost = $11,500

No. of years (n) = 4

Discount Rate (R) = 12%

So,

Present value of Annual cash operating cost = Annual cost *(1 - 1/ (1+R) ^n) / R = 11,500*(1-1/1.12^4)/.12

=11,500 *(1-1/1.12^4)/.12

= 11,500*3.037          

=34,926

So, Present value of Annual cash operating cost = 34,926

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