Question

You need a particular piece of equipment for your production process. An equipment-leasing company has offered to lease the equipment to you for $10,600 per year if you sign a guaranteed 5 -year lease (the lease is paid at the end of each year). The company would also maintain the equipment for you as part of the lease. Alternatively, you could buy and maintain the equipment yourself. The cash flows from doing so are listed below (the equipment has an economic life of 5 years). If your discount rate is 7.9% , what should you do?

Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
-$41,500	-$2,400	-$2,400	-$2,400	-$2,400	-$2,400

Select one:

a.

The NPV of the leasing alternative is -$53,000. The NPV of the purchase alternative is -$53,500. Choose the leasing alternative because it has the lowest NPV.  

b.

The NPV of the leasing alternative is -$53,000. The NPV of the purchase alternative is -$53,500. Choose the buying alternative because it has the highest NPV.  

c.

d.

The NPV of the leasing alternative is -$42,435. The NPV of the purchase alternative is -$51,108. Choose the buying alternative because it has the highest NPV.  

e.

The NPV of the leasing alternative is -$42,435. The NPV of the purchase alternative is -$51,108. Choose the leasing alternative because it has the lowest NPV.  

Answer 1

			7.90%
			NPV@ 0.079
Year	Purchase	Lease	PV factor	PV-Purchase	PV-Lease
0	(41,500.00)	-	1.000	(41,500)	-
1	(2,400.00)	(10,600.00)	0.927	(2,224)	(9,824)
2	(2,400.00)	(10,600.00)	0.859	(2,061)	(9,105)
3	(2,400.00)	(10,600.00)	0.796	(1,910)	(8,438)
4	(2,400.00)	(10,600.00)	0.738	(1,771)	(7,820)
5	(2,400.00)	(10,600.00)	0.684	(1,641)	(7,248)
			Total PV	(51,108)	(42,435)
So the Alternative E is correct and lease should be accepted having lowest PV.