Question

Emerson Corp. is trying to decide whether to lease or purchase a piece of equipment needed for the next five years. The equipment would cost $502,000 to purchase, and maintenance costs would be $20,700 per year. After five years, Emerson estimates it could sell the equipment for $100,800. If Emerson leases the equipment, it would pay $152,000 each year, which would include all maintenance costs. Emerson’s hurdle rate is 15%.

a. What is the net present value of the cost of purchasing the equipment?

b. What is the net present value of the cost of leasing the equipment?

Answer 1

Solution of a&b. NPV of the cost of purchasing the equipment and cost of leasing we can find using NPV formula in Excel:

We have applied following assumptions & calculation for the solution:

1. For discounting, we need to apply hurdle rate of 15% or 0.15 in NPV formula in this case for both purchasing and leasing cost calculation.

2. For leasing, we are following the convention of paying first lease payment at the beginning. So, lease suchedule in excel will for Year 0 to 4 and ideally year 0 value(first year lease value) is added to NPV.

3. For Maintenance & resale value calculation in case of purshasing, year 5 cashflow = -(Maintenace cost) +resale value = -20700+100800 =$80100

a.net present value of the cost of purchasing the equipment?=$521,274.20

b.net present value of the cost of leasing the equipment=$585956.71

1	A	B	C	D	E	F
2	Purchase & Maintenance				For Lease including maintenance
3	Year	Cashflow			Year	Cashflow
4	0	-502000			0	-152000
5	1	-20700			1	-152000
6	2	-20700			2	-152000
7	3	-20700			3	-152000
8	4	-20700			4	-152000
9	5	80100
10	NPV=(0.15,B5:B9)+B4	-$521,274.20			NPV=(0.15,F5:F8)+F4	-$585,956.71