Let's say that Saint Andrews Chips considers a 4th option regarding the industrial grade bagging machine. Saint Andrews Chips engineers have determine that if the firm buys the machine (without the service contract) a method can be devised by their maintenance organization to preserve and actually enhance the capability of the machine over time. By reinvesting

15% of the annual cost savings back into new machine parts, the engineers can increase the cost savings at a 5% annual rate. For example, at the end of year one, 15% of the $25,000 cost savings ($3,750) is reinvested in the machine; the net cash flow is thus $21,250. Next year, the cash flow from cost savings grows by 5% to $26,250 gross, or $22,312 net of the 15% reinvestment. As long as the 15% reinvestment continues, the cash flows continue to grow at 5% in perpetuity. Determine the net present value of this option and select the answer that comes the closest to your solution.

 

$111,111 - Correct Answer

$162,857

$18,750

$45,455

$5,203