A doctor is on contract to a medium-sized oil company to provide medical service

Question

A doctor is on contract to a medium-sized oil company to provide medical services at remotely located, widely separated refineries. The doctor is considering the purchase of a private plane to reduce the total travel time between refineries. The doctor can buy a used Learjet 31A now for $1.8 million or wait for a new very light jet (VLJ) that will be available 3 years from now. The cost of the VLJ will be $2.7 million, payable when the plane is delivered in 3 years. The doctor has asked you, his friend, to determine the present worth of the VLJ so that he can decide to buy the used Learjet now or wait for the VLJ. The MARR is 11% per year, and the inflation rate is projected to be 3.5% per year.

a) What is the present worth of the VLJ with inflation considered?

b) Which plane should he buy?

The present worth of the VLJ with inflation considered is $ .

He should .

Explanation / Answer

Real interest rate = MARR - Inflation rate = 11% - 3.5% = 7.5%

(a)

Present worth of VLJ in Constant dollars ($) = 2,700,000 x P/F(7.5%, 3) = 2,700,000 x (1.075)-3 = 2,700,000 x 0.805

= 2,173,500**

**P/F Discount factor is computed by rounding off to 4 decimals as is standard practice.

(b)

Since used Learjet costs less today since its cost is less than Present worth of VLJ, he should buy the Learjet.

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