Question

Your company is considering purchasing a used dozer for $180,000 that she could use for ten years and then sell for an estimated salvage value of $10,000. Annual maintenance and repair costs for the used dozer are estimated to be $15,000 per year. As an alternative, the contractor could lease a similar dozer for $4,000 per month. Should the company purchase the used dozer or lease the dozer from an equipment dealer? Annual operating costs are approximately the same for both alternatives. Use a minimum attractive rate of return of 12%.

Answer 1

Calculation of NPV of Cash Outflows of Dozer: Purchase alternative
Cash Outflows	Period	Amount	P.V.F @ 12%	N.P.V @ 12%
Initial Cost	0	180000	1.00000	1,80,000
Annual Costs	1-10	15000	5.6502	84,753
Salvage Value	10	-10000	0.3220	-3,220
			Total	2,61,533
Calculation of NPV of Cash Outflows of Dozer: Lease options
Cash Outflows	Period	Amount	P.V.F @ 0.95%	N.P.V @ 0.95%
Lease costs	1-10	4000	71.4164	2,85,666
			Total	2,85,666
Note: Lease are payable monthly, so the monthly discount rate is taken.
Monthly Discount Rate	=(1+12%)^(1/12)-1
	0.95%
In both alternatives, there is no cash inflow Given.
Therefore alternative with minimum NPV of Cash outflows will be choosen.
Hence, company should purchase the dozer.