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 $ 10,100 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 6.6%​, what should you​ do?

Year 0 = -$40,700

Year 1: -$2000

Year 2: -$2000

Year 3: -$2000

Year 4: -$2000

Year 5: -$2000

a.) The net present value of the leasing alternative is:

b.) The net present value of the buying alternative is:

Answer 1

Ans:- we need to choose the best alternative. For that, first, we need to find the NPV of each alternative and compare it, whichever has less NPV that alternative needs to be selected.

NPV is given by - C0 + C1 / (1 + r)^1 + C2 / (1 + r)^2 ...................Cn / (1 + r)^n, where C0 is the intial Investment and from C1 to Cn is the cash flow from year 1 to n and r is the discount rate, + sign represents inflow of cash whereas - sign represents outflow of cash.

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