A consultancy calculates that it can supply crude oil assaying services to a small oil producer for $120,000 per year for five years. There are some upfront costs the consultancy will require the oil producer to absorb. What is the maximum that these upfront costs could be, if the equivalent annual annuity to the oil company is to be under $150,000, given that the cost of capital is 10%?

Question

Quizplus · Accepted Answer

The equivalent annual annuity (EAA) is calculated using the formula for the present value of an annuity. The maximum upfront cost is determined by ensuring the total annual cost (including the annuity of the upfront cost) does not exceed $150,000. Solving for the upfront cost using the given cost of capital and annuity formula gives $113,724.

A Consultancy Calculates That It Can Supply Crude Oil Assaying