Answer:
a. I would consider consider leasing since the profits gained from leasing ($216,978,355.60) is greater compared to the profits if a spot rate is considered ($214,676,191.10) in 4 years.
b. I would consider consider leasing since the value gained from leasing ($123,553,875.20) is greater compared to the value if a spot rate is considered ($120,982,986.80) in 2 years.
Explanation:
a. Determine best option
<em>Step 1: Determine total revenue per year if they meet the demand.</em>
Total revenue per year=revenue per chair×number of chairs per year
where;
revenue per chair=Rs.20,000
number of chairs per year=4,000 units
replacing;
Total revenue per year=(20,000×4,000)=$80,000,000
<em>Step 2: Determine the net revenue per year for Leasing</em>
Net revenue=total revenue-total cost for leasing
total cost for leasing=cost per chair per square feet×area per chair×number of chairs
where;
cost per chair per square feet=10,000/100=$100
area per chair=10 square feet
number of chairs=4,000
replacing;
total cost for leasing=100×10×4,000=$4,000,000
Net revenue=80,000,000-4,000,000=76,000,000 per year
<em>Step 3: Determine the present value of the net revenue per year for Leasing</em>
Year Future cash flow Present cash flow Amount
1 76,000,000 76,000,000/{(1+0.15)^1} 66,086,956.52
2 76,000,000 76,000,000/{(1+0.15)^2} 57,466,918.71
3 76,000,000 76,000,000/{(1+0.15)^3} 49,971,233.66
4 76,000,000 76,000,000/{(1+0.15)^4} 43,453,246.67
Total present value of the future net revenue for leasing=(66,086,956.52+57,466,918.71+49,971,233.66+43,453,246.67)=
$216,978,355.60
<em>Step 3: Determine the present value for the cost for spot Market rate</em>
Since the spot market rate is paid once;
Total cost=(15,000/100)×10×4,000=$6,000,000
Total cost in four years=6,000,000×4=$24,000,000
Present value of spot rate cost=24,000,000/{(1+0.15)^4}=$13,722,077.89
<em>Step 4: Determine the present value of the revenue per year </em>
Year Future cash flow Present cash flow Amount
1 80,000,000 80,000,000/{(1+0.15)^1} 69,565,217.39
2 80,000,000 80,000,000/{(1+0.15)^2} 60,491,493.38
3 80,000,000 80,000,000/{(1+0.15)^3} 52,601,298.59
4 80,000,000 80,000,000/{(1+0.15)^4} 45,740,259.65
Present value of Total revenue=69,565,217.39+60,491,493.38+52,601,298.59+45,740,259.65=
$228,398,269
<em>Step 5: Determine the present value of the net revenue per year for sport rate</em>
Net present value=(228,398,269-13,722,077.89)=$214,676,191.10
I would consider consider leasing since the profits gained from leasing ($216,978,355.60) is greater compared to the profits if a spot rate is considered ($214,676,191.10).
b.
<em>Step 6: Consider NPV for 2 years if they Lease</em>
Year Future cash flow Present cash flow Amount
1 76,000,000 76,000,000/{(1+0.15)^1} 66,086,956.52
2 76,000,000 76,000,000/{(1+0.15)^2} 57,466,918.71
Net present value=(66,086,956.52+57,466,918.71)=$123,553,875.20
<em>Step 7: Consider total revenue if the use a spot rate</em>
Year Future cash flow Present cash flow Amount
1 80,000,000 80,000,000/{(1+0.15)^1} 69,565,217.39
2 80,000,000 80,000,000/{(1+0.15)^2} 60,491,493.38
Total revenue=(69,565,217.39+60,491,493.38)=$130,056,710.80
<em>Step 7: Consider cost for 2 years if they use a spot rate</em>
Total cost=6,000,000×2=$12,000,000
Present value=12,000,000/{(1+0.15)^2}=$9,073,724.008
Net present value=130,056,710.80-9,073,724.008=$120,982,986.80
I would consider consider leasing since the value gained from leasing ($123,553,875.20) is greater compared to the value if a spot rate is considered ($120,982,986.80) in 2 years.
