Question

FV Subcontractor Selection PV = 7+ • A General Contractor (GC) obtained bids from three local subcontractors (SC) for a job. Given that GC uses 12% per year interest rate, compounded monthly, which SC should GC select? Price Subcontractor А $40,000 Payment Schedule 50% payable now 50% payable in 1 year 30% payable in 6 months 70% payable in 1 year 75% payable now 25% payable in 1 year $42,000 $39,000

Answer 1

For the selection of subcontractors; we have to calculate the present value (PV) of the prices offered by them but first we have to calculate effective annual rate

For monthly compounding, effective annual rate (EAR) = (1 + r/m) ^m – 1

Where, r = 12% and m = 12 months

= (1 + 12%/12) ^12 - 1

= (1 + 1%) ^12 - 1

= 0.1268 or 12.68%

Now,

PV of the price of Subcontractor A = 50% of $40000 now + 50% of $40000 after one year

= $20,000 + $20,000/ (1+12.68%) ^1

= $20,000 + $17,748.98

=$37,748.98

PV of the price of Subcontractor B = 30% of $42000 in 6-months + 70% of $42000 after one year

= $12,600/ (1+12.68%/2) + $29,400/ (1+12.68%) ^1

= $11,848.65 + $26,091.01

= $37,939.65

PV of the price of Subcontractor C = 75% of $39000 now + 25% of $39000 after one year

= $29,250 + $9,750/ (1+12.68%) ^1

= $29,250 + $8,652.63

=$37,875.63

The Subcontractor A has lowest cost therefore they should be selected