Question

8. You need a particular piece of equipment for your production process. An equipment-leasing company has offered to lease the equipment to you for $10,100 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. If your discount rate is 6.9%, what should you do

Answer 1

Answer:

Find attached question containing the cash flows under the purchasing option,note that the discount rate in the attached is 7.1% but the main question has 6.9%,hence  I would make use of 6.9%

The present value of leasing option is lower,hence it is preferred.

Explanation:

The cash flows under the purchasing option is $39,200 now and $2000 each year for 5 years.

In determining the better of the two options we determine the present value of each option as follows:

leasing option=$10,100/(1+6.9%)^1+$10,100/(1+6.9%)^2+$10,100/(1+6.9%)^3+$10,100/(1+6.9%)^4+$10,100/(1+6.9%)^5=$ 41,523.11  

Purchase option=$39,200+$2000/(1+6.9%)^1+$2000/(1+6.9%)^2+$2000/(1+6.9%)^3+$2000/(1+6.9%)^4+$2000/(1+6.9%)^5=$ 47,422.40  

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