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A Plc. needs a new computer that costs £750. It can either buy it or lease...

A Plc. needs a new computer that costs £750. It can either buy it or lease it from the computer leasing company. The computer will be depreciated using a five-year MACRS schedule (see details in the formula sheet) and will be worth nothing at the end of six years. A Plc. can lease the computer with the payments of £150 (pre-paid) for six years. The corporate tax rate is 23 percent and the cost of capital is 8.5 percent.
Compare the NPV of Buy and Lease and make a decision whether the firm should buy or lease the machine.Outline the major reasons for leasing.


Solutions

Expert Solution

NPV of buy option:

NPV of Lease Option

NPV of purchase option is -£611.74 while the NPV the Lease option is -£570.64. Since the NPV of lease option is higher (in negative), the Plc. should lease the computer instead of purchase.

Apart from the higher NPV on leases as above, leasing also the following benefits:

1. Leases doesn't involve lump sum initial investment which helps the Plc. in conserving its bank line of credits.

2. Technological obsolescence can be avoided as the computer can be returned after the fixed term of lease

3. Depending on the lease type, the risk and maintenance of the computer rests with the lessor.

Thus, Plc can go for leasing option.

Workings:

Note:

Since the lease payments are pre-paid, first payment is made immediately (in year 0).

jeff jeffy answered 2 years ago
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