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 $68,000 if purchased now or an estimated $81,000 if purchased 2 years from now. At i = 10% per year and f = 5% per year, determine if the contractor should buy now or later (a) without any adjustment for inflation, and (b) with inflation considered.
What will be an ideal response?
(a) Use real i = 10%
PW = 81,000(P/F,10%,2)
= 81,000(0.8264)
= $ 66,938 < $68,000
Purchase later for $81,000
(b) Use if = 0.10 + 0.05 + (0.10)(0.05) = 0.155 (15.5% per year)
PW = 81,000(P/F,15.5%,2)
= 81,000[1/(1 + 0.155)2]
= 81,000(0.7496)
= $60,719 < $68,000
Purchase later for $81,000
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