Question

The Del Castillo Company (DCC) has decided to acquire a computer for one of its hotel.
The computer can be leased on a 5-year contract for $10,000 per year. Payments would
be made at the beginning of each year. Alternatively, DCC could purchase the computer for
$30,000 by financing the enitre cost of the computer with a loan to be amortized over a
4-year period. The annual interest rate would be 12% and payments would be due at the
end of each year. Maintenance costs estimated at $2,000 annually would be paid by the
lessor under the lease alternative. The computer is expected to have a market value of
$5,000 at the end of its useful life. Any gain on the sale will be taxed at DCC's tax rate
of 30%. Assume the computer, if purchased, would be depreciated using the double decling balance method. Assume DCC's cost of capital is 14%.
REQUIRED
1. Determine the present value of the cost of leasing.
2. Determine the present value of the cost of owning
3. Which do you recommend and why?

Answer 1

Requisites for Solving the Problem:

discount factor = 1/ (1+r)ⁿ

where 'r' is cost of capital and

'n' is year

n starts from 0 if the payments are made in the start of the year

n starts from 1 if the payments are made at the end of the year.

Loan Changes Calculation:

Closing Debt = Opening Debt - Repayment

Interest = Opening Debt * 12 %

Depreciation Calculation:

Normal Depreciation % = (Asset Value - Salvage Value)/(Age of Asset x Asset Value)

= (30000 - 5000)/(5 x 30000) = 16.67 %

Double Depreciation % = 2 x Normal Depreciation % = 33.33%

Closing Asset Value = Opening Asset Value - Depreciation During the Year

From the above figure the Book Value of Asset at the end of Year 5 = 3950.62

At the end of the 5th Year Gain on the Proceeds of the Sale = 5000 - 3950.62 = 1049.38

Answer 1.

Answer 2:

Answer 3:

My recommendation is to Purchase the Computer as purchasing the asset involves lower cost when compared to Leasing the Asset for the same usage period of 5 years.