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

$9,800

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

7.1%​,

what should you​ do?

Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
−$40,200	−$1,800	−$1,800	−$1,800	−$1,800

Answer 1

Year	Cash Flow	PV Factor	PV Of Cash Flow
a	b	c=1/1.071^a	d=b*c
1	$         -9,800	0.93371	$           -9,150.33
2	$         -9,800	0.87181	$           -8,543.72
3	$         -9,800	0.81401	$           -7,977.33
4	$         -9,800	0.76005	$           -7,448.49
5	$         -9,800	0.70966	$           -6,954.71
Present value of Lease payment			$         -40,074.58
If equipment bought
Year	Cash Flow	PV Factor	PV Of Cash Flow
a	b	c=1/1.071^a	d=b*c
0	$      -40,200	1.00000	$         -40,200.00
1	$         -1,800	0.93371	$           -1,680.67
2	$         -1,800	0.87181	$           -1,569.26
3	$         -1,800	0.81401	$           -1,465.22
4	$         -1,800	0.76005	$           -1,368.09
Present value of cost of equipment			$         -46,283.24
Since present value of cash outflow under lease payment option is lower.
Company should opt for lease option.