A mediumsize consulting engineering Him is try 1 ing to deci

A medium-size consulting engineering Him is try- 1 ing to decide whether it should remodel its office now or wait and do it one year from now. If the firm does it now, the cost will be $38,000. The interest rate is 10% per year. What would the cost have to be one year from now to render the decision indifferent. If the cost one year from now is $41,600, should the firm remodel now or later

Solution

a. Cost of remodelling office now = $38,000; Term from now = 1 year; Interest rate = 10% per annum.

Total cost of remodelling next year:

P + (PNR) / 100 where P is present cost, N term, and R interest rate.

Let’s find the interest for 1 year first: PNR / 100 = 38,000 x 1 x 10 / 100 = $3,800.

Next year’s cost of remodelling would be: 38,000 + 3,800 = $41,800. This is the cost to render the decision indifferent.

b. If the cost one year from now is $41, 600, it is better to remodel now, because it is only $200 less than the cost calculated at 10 percent annual interest.

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