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Solving Typical FE Problems

Solving Typical FE Problems

What to do: Find the Capitalized Cost of Infinite Cash Flow Sequence

How to do it: Capitalized cost refers to the present worth of cash flows which go on for an infinite period of time. For
example, if someone wanted to know how much money now (a P value) is needed to fund a permanent
$10,000 per year scholarship in their name, this involves a capitalized cost calculation. The equation is

P = A/i

Sign Convention: The sign convention of the FE Exam is used in the following examples; costs are given a
positive sign and revenues are assigned a negative sign.

Example #18: A member of congress wants to know the capitalized cost of maintaining a proposed national
park. The annual maintenance cost is expected to be $25,000. At an interest rate of 6% per year, the
capitalized cost of the maintenance would be closest to:

a. $1,500
b. $25,000
c. $150,000
d. $416,667

Solution: In this problem, A= $25,000 and i = 0.06.

More to do: If the infinite cash flow series occurs in time periods longer than the stated interest period (for
example, every three years instead of every year), the easiest way to work the problem is to convert the
recurring cash flow into an A value using the A/F factor and then divide by i.

Example #19: A dam will have a first cost of $5,000,000, an annual maintenance cost of $25,000 and minor
reconstruction costs of $100,000 every five years. At an interest of 8% per year, the capitalized cost of the
dam is nearest to:

a. $213,125
b. $525,625
c. $5,312,500
d. $5,525,625

Solution: The $100,000 which occurs every five years can be converted to an A value using the A/F factor.
Dividing the resulting A values by i will yield the capitalized cost, Pcap.

If one want to find the equivalent uniform annual worth (an A value) of an infinite cash flow, simply multiply
the capitalized cost by i to obtain A.

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