Question

A firm needs a data center with a life of three years. After three years, the data center is not needed and has no salvage value. The firm is deciding on the least costly alternative to access the data center. Under Plan A, the firm can incur an upfront cost of $120, 000. For this amount, the firm can purchase the center and move in immediately and use the facility. Under Plan B, the firm may lease the data center from owners on a monthly basis. The monthly rent is $3, 500. The firm’s borrowing cost based on APR (annual percentage rate) is 5% with semiannual compounding. Which option would you recommend to the firm? Purchase or rent? Show work. (20 pts.)

Answer 1

Answer:

Recommendation : The firm should lease the data center

Explanation:

To determine which option is better, we would compare the upfront cost of option A to the present value of the lease payment.

The present value of the lease payment is given as follows:

PV = A×  1-1+r^(-n) /r

A- semi-annual  lease payment - 3,500× 6 =  21,000

r- semi-annual interest rate = 5%/2 = 2.5%

n- number of period = 3× 2 = 6.(note that interest is compounded semi- annually i.e every six month)

PV of the lease payment =  21,000 × (1 - 1.025^(-6))/0.025 =115,670.63.

Comparing the two options, we have :

Purchase cost = 120,000

Lease cost = 115,670.63.

The lease cost is lower and would save the firm 4329.37 i.e (120,000 - 115,670.63)

Recommendation : The firm should lease the data center