Question

You need a particular piece of equipment for your production process. An equipment-leasing company has offered to lease the equipment to you for $9,900 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 6.8%, what should you do? Year 0 - $39,300 Year 1 - $2,000 Year 2 -$2,000 Year 3 - $2,000 Year 4 -$2,000 Year 5 $2,000

Answer 1

All cashflow in $; discount rate is 6.8%; Present value = current value of cashflow*discount factor

For leasing option

Year	Cashflow	Discount factor	Present value
0	-0	-	-0
1	-9000	1/(1+6.8%)^1	-8426.97
2	-9000	1/(1+6.8%)^2	-7890.42
3	-9000	1/(1+6.8%)^3	-7388.03
4	-9000	1/(1+6.8%)^4	-6917.63
5	-9000	1/(1+6.8%)^5	-6477.18

NPV=-37100.23

If buying ops is considered:

Year	Cashflow	Discount factor	Present value
0	-39300	-	-39300
1	-2000	1/(1+6.8%)^1	-1872.66
2	-2000	1/(1+6.8%)^2	-1753.43
3	-2000	1/(1+6.8%)^3	-1641.78
4	-2000	1/(1+6.8%)^4	-1537.25
5	-2000	1/(1+6.8%)^5	-1439.37

NPV=-47544.49

Since leasing option cost is less, its advisable to go ahead with that.