You are thinking about purchasing a new computer since the machine you are using

Question

You are thinking about purchasing a new computer since the machine you are using now is four years old, slow, not always reliable, and does not support the latest operating system. Your needs for the new computer are simple: anti-virus software, email, web browsing, word processing, spreadsheet, database, iTunes, and some lightweight graphical tools. Your concern is what the total cost of ownership will be for the next three years. You have to factor in a few added costs beyond just the initial purchase price for the computer itself, such as: added hardware (this could include a new printer, docking station, or scanner), software (purchase of a new operating system), training (you're thinking about pursuing web training to get an internship next term), subsequent software upgrades, and maintenance. • It is useful to think about costs over time—both direct as well as indirect costs. Part of the reason this distinction is important is that a decision should rest not on the nominal sum of the purchase, but rather on the present value of the purchase. • A dollar today is worth more than a dollar one year from now.

Explanation / Answer

Observe that the above statement is correct and relates to the capital budgeting as well as time value of money.

The capital budgeting decision is the decision of which current investment to go for with and expectation of the cash flows in future.

The future ash flows are then discounted at a particular discount rate to obtain the present value of the cash flows.

Then the summation of the present value of the cash flows is done and compared with the initial investment.

The statement that “a dollar worth today is more than a dollar one year from now” is correct because after one year the discount rate will decrease the value of the dollar invested today due to the concept of time value of money.

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