Fred's Widget Company has purchased $500,000 in equipment, which can be sold for a salvage value...

Fred's Widget Company has purchased $500,000 in equipment, which can be sold for a salvage value of $300,000 at any time. The best interest rate on alternative investments is 5%. What is the cost of using this machinery for one year? How would your answer be different if the machinery had not yet been purchased? **Please explain with details*** thank you

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Expert Solution

Machinery is bought for $500,000

Time for that machinery is used = 1 year

Selling price of machinery = $300,000

Interest rate on alternate investments = 5%

Cost of machinery would be the sum of present values of its cost

Exact cost = Cost to buy machinery - present value of benefit by selling the machinery

Present value = Future value / (1+r)ⁿ, where n is number of years and r is discount rate

In this case, discount rate is the interest rate that you can get on alternate investments i.e. 5%

n = 1 year

Future value = $300,000

So the present value of benefit = 300,000/(1+0.05)¹ = $285,714.29

So the cost of using machinery for 1 year = 500,000 - 285,714.29 = $214,285.71

If the machinery had not been purchased, then the money used to buy machinery could be invested and earned 5% interest rate

Therefore, if machinery had not been purchased, then $500,000 that is used to buy machinery would have earned 500,000*0.05 = $25,000 in 1 year

So, if machinery had not been purchased, then the company could earn $25,000 in 1 year with that money.

Rahul Sunny answered 1 year ago

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