You need a particular piece of equipment for your production process. An equipment-leasing company has offered to lease the equ
ipment to you for $ 10 comma 000 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 7.0 %, what should you do?
1 answer:
Answer: Lease Equipment as it is cheaper than Buying the Equipment
Explanation:
The better option would be the one with the lower Present Value between Leasing and Buying.
<u>Buying The Equipment </u>
Cost is $40,000 and then there will be a negative Cashflow of $2,000 every year until the 5th year.
Since the Cashflow is constant it can be treated like an annuity. Using the table attached find the PVIFA factor for 5 years at 7%.
PV = -40,000 + (-2,000 * 4.100 ( PVIFA for 5 periods at 7%))
= 40,000 - 8,200
= -$48,200
<u>Cost of Leasing </u>
Leasing would cost $10,000 per year for 5 years.
PV = -10,000 * 4.100 ( PVIFA for 5 periods at 7%)
= -$41,000
You should Lease the Equipment because it is cheaper.
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