An engineer has recently purchased a new piece of equipment to use in analyzing geological formations. The equipment has no maintenance costs the first year due to a one year's free maintenance warranty. In the second year, it is expected to cost $250 to maintain the equipment and in subsequent years the cost of maintenance will increase by $50 per year. Approximately what amount must be set aside now at 7% interest to pay the cost of maintaining the equipment over the first twelve (12) years of ownership

Explanation:

there are two out flows :

1) the payment of maintenance $250 From year 2 to 12

2) The increase in maintenance cost $50 from year 3 to 12

Calculate the present value using annuity formula for both cash outflows

1)

total payments = 11  (form year 2 to 12)

payment = $250

Rate = 7%

present value = P=R(1-(1+i )^n) / i

                           P=250(1-(1+i )^-11) / 7%  

                            P=250 *  0.5249 / 7%  

                            P=250 * 7.4986

                            P=1874.67

2)

total payments = 10  (form year 3 to 12)

payment = $50

Rate = 7%

present value = P=R(1-(1+i )^n) / i

                           P=50(1-(1+i )^-10) / 7%  

                            P=50 *  0.4916 / 7%  

                            P=50 * 7.0235

                            P=351.1791

Total payment that should be set side = 1874.67+351.1791 =2225.848

answer; comparing the additional benefits and costs;

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