Use the information below to answer the following question(s).Wet Water Company drills residential and commercial wells.The company is in the process of analyzing the purchase of a new drill.Information on the proposal is provided below:
Note: Other than the initial investment, cash flows are end of period.The working capital is returned at the end of the investment period.
-Alberta Ltd.is considering the purchase of new machinery which costs $147,800.The machine is expected to save $42,300 in operating costs annually for the next 7 years.By how much can the annual cost savings fall (to the nearest hundred dollars)and still provide a 16% return? Ignore income taxes.
A)$5,700
B)$36,600
C)$21,200
D)$42,300
E)$0

Question

Use the information below to answer the following question(s).Wet Water Company drills residential and commercial wells.The company is in the process of analyzing the purchase of a new drill.Information on the proposal is provided below:
  Note: Other than the initial investment, cash flows are end of period.The working capital is returned at the end of the investment period.
-Alberta Ltd.is considering the purchase of new machinery which costs $147,800.The machine is expected to save $42,300 in operating costs annually for the next 7 years.By how much can the annual cost savings fall (to the nearest hundred dollars)and still provide a 16% return? Ignore income taxes.
A)$5,700 
B)$36,600 
C)$21,200 
D)$42,300 
E)$0

Quizplus · Accepted Answer

The correct answer is A because the annual cost savings can fall by $5,700 and still provide a 16% return. The calculation is as follows:Present value of cost savings = $42,300 x (1 - (1 + 0.16)^-7) / 0.16 = $211,500Purchase price of machinery = $147,800Net present value = $211,500 - $147,800 = $63,700Annual cost savings required to provide a 16% return = $63,700 / 7 = $9,100Therefore, the annual cost savings can fall by $9,100 - $42,300 = $5,700 and still provide a 16% return.

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