A company is considering purchasing a new piece of manufactu

A company is considering purchasing a new piece of manufacturing machinery. If they purchase it today, the cost is $2.6 million. If they delay the purchase for three years, what will the equipment cost then, assuming i = 10% and annual inflation is 3.5%?

Solution

The cost of an asset increases by the inflation rate. Therefore, future cost of machinery would be:

Future cost = current cost x (1+ inflation rate)^n

                       = 2.6 million x (1+0.035)^3

                       = 2.6 million x 1.108718

                        = 2.883 million

So cost in three years would be 2.883 million.