Question from the Chartered Institute of Management Accountants, Stage 1, May 1995. (30 minutes)

The Management Services Division of a company has been asked to evaluate the following proposals for the maintenance of a new boiler with a life of seven years: jki8

REQUIRED 1. Calculate the maintenance cost for each year if the company provides its own maintenance. (4 marks)
2. Calculate the present value of the cost of maintenance, if the company carries out its own maintenance. (4 marks)
3. Calculate the present value of the supplier’s maintenance contract. (3 marks)
4. Recommend, with reasons, which proposal should be adopted. (4 marks)
Total marks = 15

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Proposal 1 The boiler supplier will make a charge of 13,000 per year on a seven- year contract. Proposal 2 The company will carry out its own maintenance estimated at $10,000 per annum now, rising at 5% per annum with a major overhaul at the end of year 4 costing an additional 25,000. The discount rate is 10% and all payments are assumed to be made at year ends.