Question

A company needs a new piece of equipment which can be purchased today for $7,250.

Alternatively, a leasing agreement is available that requires payments of $192 at the beginning of each month for three years and provides a $1,500 option to buy the equipment at the end of three years. Interest is 8% compounded monthly.

Using the discounted cash flow method (DCF), should the equipment be leased or purchased?

Answer 1

We need to calculate the present value of payments in leasing to decide.

Interest rate per Monthly Period= 8%/12= 0.667%

Present value= 192+192/(1+0.667%)+192/(1+0.667%)^2+....192/(1+0.667%)^35+1500/(1+0.667%)^36

we can use the formula of present value of annuity which is C*(1-(1+r)^-n)/r; where C is the periodic cashflow, r is the discount rate and n is the number of periods.

Present value= 192+192*(1-(1+0.667%)^-35)/0.667%+1500/(1+0.667%)^36

= $7348.80

As Present value of Payments in leasing is more than that of $7250, which is the present value of Purchase, the equipment should be purchased.