A regional infrastructure building and maintenance contractor must decide to buy

Question

A regional infrastructure building and maintenance contractor must decide to buy a new compact horizontal directional drilling (HDD) machine now, or wait and buy it 2 years from now when a large pipeline contract will require the new equipment. The HDD machine will include an innovative pipeloader design and a maneuverable undercarriage system. The cost of the system is $65,800 if purchased now or an estimated $80,700 if purchased 2 years from now.

At i = 12% per year and f = 5% per year, determine if the contractor should buy now or later with inflation considered.

The contractor should buy the drilling machine for $ .

Explanation / Answer

Inflation Consider Formula = i + f + if

i = interest rate ; f = inflation factor rate ; if = interest rate X inflation factor rate

i=12% ; f = 5% ;

= 12/100 + 5/100 + 12/100 X 5/100

= 0.12 + 0.05 + 0.12 X 0.05

= 0.12 + 0.05 + 0.006

= 0.176

Cost of system = $ 65,800 (purchaed now)

So Consider Cost of system (purchased now) = $ 65,800 (Present Value)

Inflation considerred = 0.176 ; No. of Years = 2 years

Future Value = P.V. X ( 1 + i )^n

P.V. = Present Value ; i = inflation consider ; n= no. of Years

P.V. = $65,800; i = 0.176; n = 2 years

= $65,800 X (1 + 0.176) ^ 2

   = $65,800 X (1.176)^2

   = $65,800 X 1.382

   = $90,935.6

Compare this amount $ 90,935.6 with Estimated amount $ 80,700

'So Contractor should "buy Later" with inflation considered'

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