Reference no: EM133004735

Suppose now it is the end of 2021. A construction company for a gas pipeline project, CPM Construction, brought a trencher for $200,000 in the beginning of 2020. The life of this trencher is expected to be 7 years from the time of purchase. In the past two years, the annual operating cost was $50,000 and the annual revenue made by this truck was $80,000, and it is expected that the annual operating cost will remain unchanged, but the annual revenue may reduce to $75,000 in the following years from Year 2022 to the end of the life of this trencher. At the beginning of 2024, it is necessary to do major repair, and the expected cost is $20,000. There is no any other major repair expected to the end of the life of this trencher. At the end of the life, this trench is expected to have a value of $10,000, which is the expected amount of cash that CPM will get when its life is over (e.g., sell it to a dealer) . Answer the following two questions.

(1) If the MARR of this company is 12%, what is the equivalent annuity?

(2) If CPM wants to sell it just before the major repair at the beginning of 2024, what the lowest price should CPM ask, so that it will not be worse off, compared with the original plan (i.e., keep it to the end of the life)

Hint: at this time, suppose you are standing at the time point just before the repair, implying that if you do not sell it, you have to pay for the repair now; or sell it for cash now. However, no matter you repair or sell it, at that time point, you would have received the revenue and paid for operating cost for Year 2023.