Question

ABC Company wants to buy diesel generator at a price of $1,600,000,000 . The alternatives are as follows:
-Buy cash at a price of $1,600,000,000
OR
-Rent at a price of $30,000,000 per month.
Assumption of a deposit interest of 7% a year. In your opinion, which one to choose ?

Answer 1

ABC company has two option.

We will have to evaluate both the option

Option 1 : Buy Diesel generator

Cash outflow for the year = $ 1600000000

Option 2 : Take Generator on the rent

Cash outflow for the month = $ 30,000,000

Now total cashflows are $ 1600000000

less: cashflow for the month $ 30000000

Remaing cash $ 1570000000 ( this can be deposited in the bank and company can earn the interest on the interest @7 % p.a)

Calculation of Interest earned

EXPLANATION FOR ABOVE CALCULATION

(For the above calculation first we will calculate cumulative Interest and then we will calculate Interest for the month by subtracting interest for the earlier periods

FOR example we are calculating interest for 3rd moth then we will have to subtract interest earned for 1st and 2nd month

like Interest for 12 month - Interest for 10 months

109900000-88083333 = 21816667 this is interest for two months

now from that we will have to deduct interest earned for 1st and 2nd month i.e. 21816667-11083333-2100000=8633333 )

While choosing rent option e can earn the interest of $ 664300000

Net Cash outflow for the year will be $ 30,000,000 * 12 = $ 360,000,000

Less : Interest earned = $ 113,050,000

Net Cash outflow Will be = $ 246,950,000

ABC company should choose the option of taking generator on rent.

NOTE : The above proposals can be effectively evaluated if the information about life of generator, Depreciation and other cost would have been provided in the question.

Here for want of information we have calculated only for 1 year cash outflow only