Question

A small manufacturing company is considering purchasing a maintenance contract for its air conditioning systems. Since all of its systems are new, the company plans to begin the contract in year one and continue through year ten. The cost of the contract is $3,200 per year and the company's minimum attractive rate of return is 12% per year. The present worth of the contract is nearest to

Answer 1

$18,080.71

Step-by-step explanation:

This can be computed by using the formula for calculating the present value of an ordinary annuity as follows:

PV = P × [{1 - [1 ÷ (1 + r)]^n} ÷ r] …………………………………. (1)

Where;

PV = Present value or worth of the contract?

P = yearly cost of the contract = 3,200

r = annual rate of return = 12%, or 0.12

n = number of years = 10

Substitute the values into equation (1) to have:

PV = $3,200 × [{1 - [1 ÷ (1 + 0.12)]^10} ÷ 0.12]

PV = $3,200 × 5.65022302841087

PV = $18,080.71

Therefore, the present worth of the contract is nearest to $18,080.71.