Question

Problem 1: Company X is specialized in selling construction materials. It offers deferred payment plans for contractors. You, as a contractor, decided to accept X offer to supply your company with a fixed amount of Portland cement of value of 200 OMR per two weeks for nine months. The offer states that you will pay a full lump sum amount at the end of nine months with an interest rate of 2% per semi-monthly. The offer states that if you stopped buying the Portland cement in any time before the completion of nine months, the full payment due at the stopped month (Principal + interest) in addition to the interest for the remaining period would automatically become due. After three months, you realized the offer was expensive, and you found a similar offer with an interest rate of 2% per three-quarter for a supplied value of cement equals to OMR 300 per three weeks. You decided to buy the cement from another supplier for the rest of the period, and X asked you to pay your debt as per the contract. X also offered you another alternative instead; X reduced the interest rate to 1.9 per semi-monthly for the rest of the remaining period. Which of these alternatives should you accept? Explain. Support your answer by drawing the cash flow diagram.

Answer 1

We have two alternatives -

Alternative 1 - To on board the new vendor .

Alternative 2 - To continue with the first vendor that is X at reduced interest rates.

Statement showing the comparison of both the vendors

Particulars	Alternative 1	Alternative 2
Sunk Cost (WN1)	1344	1344
Interest paid to X on remaining 6 months (WN2)	288	-
Cement cost for next 6 months (WN3)	2400	2400
Interest cost for next 6 months	32	547
Total cost	4064	4291
Profit	227

It is suggested to onboard new vendor.

Working Notes

Working Note 1 - Calculation of sunk cost

Cost of cement for three months = 200 OMR * 2 * 3 months = 1200 OMR

Cost of Interest payment for three months = 1200 OMR * {(2*2)* 12}% 3/12 = 144 OMR

Total Sunk Cost = 1200 + 144 = 1344 OMR

Working Note 2 - Interest payment for remaining 6 months = 1200*48%*6/12 = 288 OMR

Working Note 3 - Cement cost for next three months

New Vendor = {300 OMR/3 weeks} * {6months * 4weeks} = 2400 OMR

Vendor X = (200 OMR * 2 * 6 months) = 2400 OMR

Working Note 4 - Interest cost for next 6 months

New Vendor = {2400 * (2/3quarters*4Quarters)% * 6/12} = 32 OMR

Vendor X = {2400 * (1.9 * 2 * 12)% * 6/12} = 547 OMR

Please upvote in case you find the solution helpful, and in case of any suggestion or query please write me in comments.