Flantronics Inc. is a company that designs, makes, and sells computer and home e

Question

Flantronics Inc. is a company that designs, makes, and sells computer and home entertainment sound systems, along with a line of headphones and microphones for personal digital media. The company is trying to decide whether it should purchase or lease a building for its manufacturing and research-and-development operation in China. If the building is leased, a payment will have to be made at the beginning of each year. The estimated costs are the following:

Which alternative should be recommended ? Use a MARR of 9%.

Alternative Purchase Lease Initial Cost $320,000 - Lease - $40,000 Annual Operating Costs $8500 $7000 Salvage Value $80,000 - Life, years 7 1

Explanation / Answer

Hi,

Please find the detailed answer as follows:

Step 1 - Calculate Net Present Value for Both the Options:

Purchase:

Initial Investment = -320000

Annual Operating Costs = -8500

Net Present Value = -320000 - 8500/(1+.09)^1 - 8500/(1+.09)^2 - 8500/(1+.09)^3 - 8500/(1+.09)^4 - 8500/(1+.09)^5 - 8500/(1+.09)^6 - 8500/(1+.09)^7 + 80000/(1+.09)^7 = -319017.36

Lease:

Net Present Value = -40000 - 7000/(1+.09)^1 = -46422.02

Step 2 : Calculate Equivalent Annual Cost for Both the Options

Purchase:

Equivalent Annual Cost = Net Present Value/PVIFA(9%,7 Years) = -319017.36/5.0330 = -63385.13

Lease

Equivalent Annual Cost = Net Present Value/PVIFA(9%,1 Years) = -46422.02/.9174 = -50601.72

Since Equivalent Annual Cost of Lease option is less, we should select the Lease Option

Thanks.

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