Question

A small strip-mining coal company is trying to decide whether it should purchase or lease a new clamshell. If purchased, the shell will cost $150,000 and is expected to have a $65,000 salvage value in 6 years. Alternatively, the company can lease a clamshell for $30,000 per year, but the lease payment will have to be made at the beginning of each year. If the clamshell is purchased, it will be leased to other strip-mining companies whenever possible, an activity that is expected to yield revenues of $12,000 per year. If the company's minimum attractive rate of return is 15 % per year, should the clamshell be purchased or leased on the basis of a future worth analysis?

Answer 1

Answer:

The clamshell should be purchased.

Explanation:

Note: see the attached for the calculation of the net future worth (NFW) of the two options.

NFW of Buy Option =  $121,150.54

NFW of Lease Option = –$302,003.98

Since the $121,150.54 NFW of the buy option is positive, while the $302,003.98 NFW of the lease option is negative, the clamshell should be purchased.

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