Question

A consultancy calculates that it can supply crude oil assaying services to a small oil producer for $115,000 per year for five years. There are some upfront costs the consultancy will require the oil producer to absorb. What is the maximum that these upfront costs could be, if the equivalent annual annuity to the oil company is to be under $160,000, given that the cost of capital is 9%

Answer 1

$175,034

Step-by-step explanation:

The question asks us to calculate the maximum upfront cost.

This can be calculated by making use of the following mathematical formula;

Upfront cost = (equivalent annuity - annual cost) * present annuity

We identify the parameters in the formula as:

Equivalent annuity = $160,000

Annual cost = $115,000

Present value annuity = (1-1.09^-5)/0.09

= 3.889651

Upfront cost = (160,000-115000)* 3.889651 = 45,000 * 3.889651 = $175,034