A currently used machine costs $10,000 annually to run.What is the maximum that should be paid to replace the machine with one that will last three years and cost only $4,000 annually to run? The opportunity cost of capital is 12 percent.
A)$2,000
B)$9,607
C)$14,411
D)$24,018

Question

Quizplus · Accepted Answer

The maximum that should be paid to replace the machine can be calculated using the Net Present Value (NPV) of the cost savings. The annual savings from the new machine would be $10,000 - $4,000 = $6,000. Over three years, at a 12% discount rate, the NPV of these savings is calculated as: NPV = $6,000 / (1+0.12)^1 + $6,000 / (1+0.12)^2 + $6,000 / (1+0.12)^3 = $5,357.14 + $4,783.93 + $4,270.30 = $14,411.37. Therefore, up to $14,411 could be paid to replace the machine and still break even on the investment.

A Currently Used Machine Costs $10,000 Annually to Run