Question

A software company that installs systems for inventory control using RFID technology spent $600,000 per year for the past 3 years (year 0, year -1, year -2) in developing their latest product. The company wants to recover its investment in 5 years beginning now. If the company signed a contract that will pay $250,000 now and amounts increasing by a uniform amount each year through year 5, (a) how much must the increase be each year? Use an interest rate of 15% per year. (b) Please draw the cash flow diagram.

Answer 1

a) Let the increase each year = G

Development cost, year 0 = 600,000(F/A,15%,3) = 600,000(3.4725) = $2,083,500 Present worth of income, year -1 = 250,000(P/A,1596,6) + G(P/G,15%,6) = 250,000(3.7845) + G(7.9368) Move development cost to year -1 and set equal to income 2,083,500(P/F,15%,1) = 250,000(3.7845) + G(7.9368) 2,083,500(0.8696) = 250,000(3.7845) + G(7.9368) G = $109,072

b) Cash flow

$461,288 IN $352216 $243144 $134072 $25,000 0 1 2 3 4 5 6 $60,000 $60000 $60000 Years