Question：A contract is to be commenced immediately. In one year’s time it will require material EH. The material costs $7,800 now but will cost $8,800 in one year’s time. The cost of storing EH for one year is $110 payable in one year’s time.
If the contractor’s cost of capital is 10% per annum, what is the present value of using the material if the contractor wishes to maximise profit?
A. $7,999
B. $7,800
C. $7,900
D. $7,910
The correct answer is:$7,900.
If the contractor buys the material now, the present value of the cost is $(7,800 +($110 × 0.909) = $7,900.
If he buys it in a year’s time, the present value of the cost is $8,800 × 0.909 = $7,999.
The contractor should chose the lower of the two as he wishes to maximise profit.
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