Question

# You need a particular piece of equipment for your production process. An equipment-leasing company has offered...

You need a particular piece of equipment for your production process. An equipment-leasing company has offered to lease the equipment to you for \$ 10 500 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 Year 1 Year 2 Year 3 Year 4 Year 5 -40600 -1800 -1800 -1800 -1800 -1800

a) The net present value of the leasing alternative is \$

b) The net present value of the buying alternative is \$

Answer: Present Value Formula: Cash Flow /(1 + Discount rate) ^ ( no of years)

Discount rate = 6.6%

 Year 0 1 2 3 4 5 Cash Flow 0 -10500 -10500 -10500 -10500 -10500 Present Value ( Cash flow/(1+ 0.066)^( no of years) 0 -9849.91 -9240.06 -8667.98 -8131.31 -7627.87 Net Present value -43517.1

Present cash outflow value of leasing the equipment is 43517 (outflow)

 Year 0 1 2 3 4 5 Cash Flow -40600 -1800 -1800 -1800 -1800 -1800 Present Value ( Cash flow/(1+ 0.066)^( no of years) -40600 -1688.56 -1584.01 -1485.94 -1393.94 -1307.63 Net Present value -48060.1

Present Value of Owning the equipment 48060 (outflow)

So leasing the equipment is the better option as it leads to less cash outflow