Answer:
The lease option is the better option.
Explanation:
We proceed as follows:
Step 1: Calculation of Lease Option NPV
Year = n Details CF ($) DF = 1/(1.1)^n PV ($)
1 Lease payment (30,000) 0.9091 (27,273)
2 Lease payment (30,000) 0.8264 (24,793)
3 Lease payment (30,000) 0.7513 (22,539)
4 Lease payment (30,000) 0.6830 (20,490)
Lease option NPV = (95,096)
Step 1: Calculation of Lease Option NPV Buy Option NPV
Year = n Details CF (CO) DF = 1/(1.1)^n PV
0 Purchase cost (80,000) 1.0000 (80,000)
1 Maintenance expenses (10,000) 0.9091 (9,091)
2 Maintenance expenses (10,000) 0.8264 (8,264)
3 Maintenance expenses (10,000) 0.7513 (7,513)
4 Maintenance expenses (10,000) 0.6830 (6,830)
4 Residual value 20,000 0.6830 13,660
Buy option NPV = (98,038)
Step 3: Calculation of equivalent annual annuity (EAA)
The equivalent annual annuity (EAA) for each option can be calculated as follows:
EAA = (r x NPV) / (1 - (1 + r)^-n )
Where:
EAA = equivalent annuity cash flow
NPV = net present value
r = discount rate per period
n = number of periods
Therefore, we have:
Lease option EAA = (0.1 × -95,096) / (1 - (1 + 0.1)^-4) = -30,000
Buy option EAA = (0.1 × 98,038) / (1 - (1 + 0.1)^-4) = -30,928
Since the lease option has a lower EAA of $30,000 in terms of cash outlay than the buy option of higher EAA of $30,928 in terms of cash outlay, the lease option is the better option.
