Question

Rearden Metal needs to order a new blast furnace that will be delivered in one year. The $1,000,000 price for the blast furnace is due in one year when the new furnace is installed. The blast furnace manufacturer offers Rearden Metal a discount of $50,000 if they pay for the furnace now.

1. If the interest rate is 4% (applicable for both borrowing and investment), what Rearden Metal should do?
2. Which decision Rearden must take If Rearden does not have cash currently (but expects to have it in the future). Explain, provide computations supporting your answer.

Answer 1

Answer : (a.) Calculation of Amount Rearden Metal needs in order for New Blast furnace if paid after one year

Amount to be paid after one year = 1,000,000 / (1 + 0.04)^1

= 961,538.46153

Amount if Paid Today = 1,000,000 - 50000

= 950,000

Therefore Reardon should pay today as it cost less in present value Terms .

(b.) In case Reardon Does not have Cash Now ,

we will evaluate Borrowing Option and to defer payment Option :

Evalualtion of Borrowing Option :

Borrow $950,000 (1,000,000 - 50000) for one year and repay later .

Amount due after one year = 950,000 * 1.04 = 988,000

Defermnent Option

Amount to be paid after one year = 1,000,000

Therefore Reardon should opt for payment of Price today only by Borrowing the required Amount