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 $ 10 comma 000 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 7.0 %​, what should you​ do?

Answer 1

Answer: Lease Equipment as it is cheaper than Buying the Equipment

Step-by-step explanation:

The better option would be the one with the lower Present Value between Leasing and Buying.

Buying The Equipment

Cost is $40,000 and then there will be a negative Cashflow of $2,000 every year until the 5th year.

Since the Cashflow is constant it can be treated like an annuity. Using the table attached find the PVIFA factor for 5 years at 7%.

PV = -40,000 + (-2,000 * 4.100 ( PVIFA for 5 periods at 7%))

= 40,000 - 8,200

= -$48,200

Cost of Leasing

Leasing would cost $10,000 per year for 5 years.

PV = -10,000 * 4.100 ( PVIFA for 5 periods at 7%)

= -$41,000

You should Lease the Equipment because it is cheaper.