Question

Suppose you are studying two hardware lease proposals. Option 1 costs $5,000, but requires that the entire amount be paid in advance. Option 2 requires $2000 now and $1,000 per year for the next four years. If you do an NPV analysis assuming a 12% discount rate, which proposal is less expensive? What happens if you use an 18% rate?

Answer 1

Option 1 is better as it incurrs less cash outflows Option 2 NPV @12% Year Cash Outflows Present Value factor @ 12% $2,000.00 $1,000.00 0.893 $1,000.00 0.797 $1,000.00 0.712 $1,000.00 0.636 NPV WN Present cash flows $2,000.00 $893.00 $797.00 $712.00 $636.00 $5,038.00 Cash Outflow Option 1 $5,000.00 Option 2 $5,038.00 Option 2 is better as it incurrs less cash outflows Option 2 NPV @18% Year Cash Outflows Present Value factor @ 12% $2,000.00 $1,000.00 0.847 $1,000.00 0.718 $1,000.00 0.609 $1,000.00 0.516 NPV NM Present cash flows $2,000.00 $847.00 $718.00 $609.00 $516.00 $4,690.00 Cash Outflow Option 1 $5,000.00 Option 2 $4,690.00