Question

A diesel generator for electrical power can be purchased by a remote community for $480,000 and used for 10 years, when its salvage value is $50,000. Alternatively, it can be leased for $70,000 a year. (Remember that lease payments occur at the start of the year.) The community’s interest rate is 8%. What is the interest rate for buying versus leasing? What is the better choice?

Answer 1

The interest rate for buying versus leasing a diesel generator can be calculated using the Net Present Value (NPV) formula. The better choice depends on the calculated NPVs for both options.

Step-by-step explanation:

The interest rate for buying versus leasing can be calculated using the Net Present Value (NPV) formula. For buying the diesel generator, the initial cost is $480,000 and the salvage value after 10 years is $50,000.

The present value of the annual savings from buying is calculated as the difference between the lease cost of $70,000 and the salvage value of $50,000, discounted back to present value using the interest rate. For leasing, the annual lease cost is $70,000.

By calculating the NPV for both options at an 8% interest rate, we can determine which option is better financially. If the NPV of buying is higher than leasing, it means that buying is the better choice.

On the other hand, if the NPV of leasing is higher, it means that leasing is the better choice. Based on the calculated NPVs, the option with the higher NPV is the better choice.

The interest rate for buying versus leasing is 8%. Therefore, the better choice depends on the calculated NPVs for both options.