Question

1. Good Motors produces automobiles. Due to an urgent need for ventilators, Good Motors must retool its production line to start producing ventilators This can be done by buying needed production equipment. The after tax cash flow for buying this equipment is $750,000, at the beginning of Year 0. The alternative to produce the same output, is to lease that same equipment through four equal payments of $235,000 each year paid at the beginning of the year. The required rate of return (hurdle rate) for this business is 8 percent. Assume no taxes. Revenue from sales of the ventilators is expected to be:

• Year 1 - $515,000
• Year 2 – $310,000
• Year 3 – $170,000
• Year 4 – $80,000

Calculate the net present value of both the new purchase option and the lease option. Show all work. Determine the best option for Good Motors and justify your answer.

Answer 1

Calculation of NPV of both option :-

Year	Cash flow (Buying)	Cash flow (Leasing)	PVF @8%	Present value (Buying)	Present value (Leasing)
a	b	c	d	e=b*d	f=c*d
0	-750000	0	1	-750000	0
1	515000	280000	0.925925926	476851.85	259259.26
2	310000	75000	0.85733882	265775.03	64300.41
3	170000	-65000	0.793832241	134951.48	-51599.10
4	80000	-155000	0.735029853	58802.39	-113929.63
			NPV	186380.76	158030.95

NPV of buying option = $186,380.76

NPV of leasing option = $158,030.95

Buying option would be best for Good motors beacause it will generate additional NPVamounting to $28,349.81 ($186380.76 - $158030.95) over the life of asset.

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