Question

Your cousin, responsible for the theatrical activities of a small school board, you
contact to rent from your company the equipment necessary for the activities of the
different schools for which it is responsible for the next two years. The
school board is willing to pay $ 8,000 at the end of the first year,
then $ 9,000 at the end of the second year.

After contacting the different distributors and manufacturers of this material, gather
the following three propositions.

Proposal A
You can rent a minimum quality material from a new distributor. The cost
annual lease would be $ 3,200, payable at the beginning of each year. In addition, you would be
responsible for the maintenance of the equipment during the contract. You estimate these costs at $ 400 to
the end of the first year, and at $ 800 at the end of the second year.

Proposal B
You can rent medium quality equipment from a major national distributor.
The annual rental cost would be $ 4,200, payable at the beginning of each year. In addition, you
be responsible for the maintenance of the equipment during the contract. You estimate these costs to
$ 220 at the end of the first year, and $ 430 at the end of the second year.

Proposal C
You buy a high-end material. The required investment is $ 15,000 and you
plan to resell without difficulty this equipment $ 13,500 in two years. This material
should require no maintenance expense over the next two years.

The tax rate of your firm is 38% and the opportunity cost of the invested funds
(the discount rate) of 18%. If you choose to buy the equipment, it must be
amortized using the declining balance method at an annual rate of 30%. Finally, because you do not have no other contracts in the short term, you decide to play the card of caution and assume that your business will be closed after the second year of the contract. There will be no class closure at this time.
Which of the proposals is most favorable to you? Present your calculations, for each
proposals, and clearly state your choice.

Answer 1

Since we are to compare the projects, we will look only at incremental costs. Hence amount paid by school board is considered irrelevant.

Option A has the least cost.

Lease options are considered after tax due to tax saving on expenses. Buy option requires addition of tax saving on depreciation.

Year	A	B	C
0	-1984	-2604	-15000
1	-2232	-2740.4	1710
2	-496	-266.6	12360
NPV	-4231.74	-5117.84	-4674.09

WORKINGS

Year	Opening balance	Depreciation	Closing balance
1	15000	4500	10500
2	10500	3150	7350
		Profit on sale	6150
		Tax on sale	2337
		Net proceeds from sale	11163