Your company owns a piece of manufacturing equipment that requires a lot of maintenance. You estimate that the maintenance costs will be $750 next year (Year 1), and will increase by $250 each year until Year 8, at which point you will discard the equipment (after paying the maintenance costs for that year - there is a cash flow in Year 8). You want to know how much money you should put aside now to pay for this maintenance (the present value of the cash flows at Year 0), assuming an interest rate of 5% per year.

a. To solve for the present value in Year 0, you need to split the cash flows into two pieces. What are these pieces?

b. How much money do you need to put aside now to pay for the maintenance?

c. If you converted the maintenance costs into an equivalent uniform annual cost (an annuity) over the 8 years, what would that annual cost be?

a. To solve for the present value in Year 0, you need to split the cash flows into two pieces. What are these pieces?

Piece 1:

A.

An annuity of $750 for 8 years

B.

An annuity of $500 for 8 years

C.

An annuity of $750 for 7 years

D.

An annuity of $700 for 7 years

Piece 2:

A.

A uniform gradient of $250 for 7 years

B.

A uniform gradient of $750 for 8 years

C.

A uniform gradient of $750 for 7 years

D.

A uniform gradient of $250 for 8 years