Question

You are the manager of a large​ crude-oil refinery. As part of the refining​ process, a certain heat exchanger​ (operated at high temperatures and with abrasive material flowing through​ it) must be replaced every year. The replacement and downtime cost in the first year is ​$175 comma 000175,000. This cost is expected to increase due to inflation at a rate of 77​% per year for sixsix years​ (i.e. until the EOY 77​), at which time this particular heat exchanger will no longer be needed. If the​ company's cost of capital is 1515​% per​ year, how much could you afford to spend for a higher quality heat exchanger so that these annual replacement and downtime costs could be​ eliminated?

Answer 1

The company could pay up to 866,965.89 dollars today to solve the current heat exchanger situation

Step-by-step explanation:

We have to determinate the present value of 7 year annuity which increase at a rate of 7% when the cost of capital is 15% being the first quota 175,000 dollars

`(1-(1+g)^(n)* (1+r)^(-n) )/(r - g)`

grow rate 0.07

required return 0.15

Cuota 175,000

n 7

PV = 866,965.89