Question

Chiwen, Inc. is considering whether to replace an office copy machine with a new model.  The manager is trying to decide whether to buy the machine outright or lease it from a copier company.  He has generated the following information about the two options.

Purchase Option		Lease Option
Purchase price	$ 25,000	Annual lease payment (includes all supplies and maintenance)	$ 7,000
Annual operating costs (paper, toner, maintenance, etc.)	$ 2,000
Useful life	5 years	Contract length	5 years
Salvage value	$ 5,000

Chiwen’s discount rate is 12 percent.  Should the company lease or buy the copier?

Answer 1

(i) To purchase of new machine

	Amount ($)
Present value of after-tax cash outflows
Cost of purchase
Equivalent annual cost for 5 years = 25000 3.605	6934.81
Running and maintenance cost per annum	5000.00
Total net equivalent cash outflows p.a.	11934.81

(ii) Lease a new machine

	Amount ($)
Lease Rent	7000.00
Total net equivalent cash outflows p.a.	7000.00

(iii) Since, net equivalent cash outflows p.a. for buying a new machine $ 11934.81 is HIGHER than net equivalent cash outflows of $ 7000.00 for Lease a new machine. Therefore, it is advisable that the company should go for Lease a new machine.

WORKING NOTES

1⋅PVAF5/.12=1(1−(1+.12)−5.12)=1(1−0.5674268557186.12)=1(3.604776202345)=3.604776202345