A company wants to buy an equipment. The management of the company is considering the following two plans: Plan A Buy now Plan B Buy later If the company selects plan A, the equipment will be purchased now for ₹10,00,000. However, if the company selects plan B, the purchase will be deferred for 4

Question

A company wants to buy an equipment. The management of the company is considering the following two plans:
Plan A Buy now
Plan B Buy later
If the company selects plan A, the equipment will be purchased now for ₹10,00,000. However, if the company selects plan B, the purchase will be deferred for 4 years when the cost is expected to ₹17,00,000. The company expects a real M.A.R.R. of [latex]10\%[/latex] per year. The average inflation rate in the country is [latex]8\%[/latex] per year. Determine whether the company should purchase now or later (a) when inflation is not considered and (b) when inflation is considered.

Accepted Answer

(a) Inflation not considered: Calculate the F.W. value for plan A at an interest rate i = M.A.R.R. = [latex]10\%[/latex] and n = 4 years. Compare the calculated F.W. value with the expected cost of plan B, i.e., ₹17,00,000 and select the one having the lower cost.

[latex]\left(F.W.\right)_{Plan A} = -₹10,00,000\left(F/P,10\% ,4\right) = -₹10,00,000\left(1.4641\right) = -₹14,64,100[/latex]

[latex]\left(F.W.\right)_{Plan B} = -₹17,00,000[/latex]

Select plan A, i.e., purchase now.
(b) Inflation considered: First calculate the inflation-adjusted M.A.R.R. as:

[latex]i_{f} = i + f + if = 0.10 + 0.08 + (0.10)(0.08) = 0.188[/latex]

Use [latex]i_{f}[/latex] to compute F.W. for Plan A:

[latex]\left(F.W.\right)_{Plan A} = -₹10,00,000\left(F/P,18.8\% ,4\right) = -₹10,00,000\left(1.9927\right) = -₹19,92,700[/latex]

[latex]\left(F.W.\right)_{Plan B} = -₹17,00,000[/latex]

Select plan B, i.e., purchase later.

Question 10.4: A company wants to buy an equipment. The management of the c...

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