Question

Differential Analysis for a Lease or Buy Decision

Laredo Corporation is considering new equipment. The equipment can be purchased from an overseas supplier for $3,240. The freight and installation costs for the equipment are $620. If purchased, annual repairs and maintenance are estimated to be $410 per year over the four-year useful life of the equipment. Alternatively, Laredo Corporation can lease the equipment from a domestic supplier for $1,420 per year for four years, with no additional costs.

Prepare a differential analysis dated March 15 to determine whether Laredo Corporation should lease (Alternative 1) or purchase (Alternative 2) the equipment. (Hint: This is a “lease or buy” decision, which must be analyzed from the perspective of the equipment user, as opposed to the equipment owner.) If an amount is zero, enter "0".

Differential Analysis
Lease (Alt. 1) or Buy (Alt. 2) Equipment
March 15
	Lease Equipment (Alternative 1)	Buy Equipment (Alternative 2)	Differential Effects (Alternative 2)
Costs:
Purchase price	$	$	$
Freight and installation
Repair and maintenance (4 years)
Lease (4 years)
Total costs	$	$	$

Determine whether Laredo should lease (Alternative 1) or buy (Alternative 2) the equipment.

Answer 1

Repair and maintenance (4 years) = Annual Repair and maintenance cost x 4

= 410 x 4

= $1,640

Lease charges for 4 year period = Annual lease charges x 4

= 1,420 x 4

= $5,680

Differential Analysis
Lease (Alt. 1) or Buy (Alt. 2) Equipment
March 15
	Lease Equipment (Alternative 1)	Buy Equipment (Alternative 2)	Differential Effects (Alternative 2)
Costs:
Purchase price	$0	$3,240	- $3,240
Freight and installation	0	620	- 620
Repair and maintenance (4 years)	0	1,640	- 1,640
Lease (4 years)	5,680	0	5,680
Total costs	$5,680	$5,500	$180

Laredo should buy (Alternative 2) the equipment since the total cost of buying is less than cost of leasing.

Please ask if you have any query related to the question. Thank you