2) A firm is evaluating whether to lease or purchase four trucks. The four truck

Question

2) A firm is evaluating whether to lease or purchase four trucks. The four trucks can be purchased for a total cost of $240,000 and operated for maintenance, insurance and general operating costs of $20,000 at year 0, $40,000 at year 1, $50,000 at year 2, and 30,000 at year 3 with an expected salvage value of $100,000 at the end of year 3. The four trucks could be leased for $120,000 per year, for the three years. The lease cost includes maintenance costs but do not include insurance and general operating costs of $10,000 at year 0, $20,000 per year at years 1 and 2 and $10,000. If the discounting rate is 15% before tax considerations, using NPV analysis determine if economic analysis dictates leasing or purchasing

Explanation / Answer

We compute NPV as follows.

Since Purchasing has a lower negative NPV, this is best alternative.

IF PURCHASED: Year Cost ($) Benefit ($) Net Benefit ($) Discount Factor @15% Discounted Net Benefit ($) (A) (B) (C) = (B) - (A) (D) (C) x (D) 0 2,60,000 -2,60,000 1.0000 -2,60,000 1 40,000 -40,000 0.8696 -34,783 2 50,000 -50,000 0.7561 -37,807 3 50,000 1,00,000 50,000 0.6575 32,876 NPV ($) = -2,99,714 IF LEASED: Year Lease Cost ($) O&M Cost ($) Total Cost ($) Discount Factor @15% Discounted Total Cost ($) (A) (B) (C) = (A) + (B) (D) (C) x (D) 0 -20,000 -20,000 1.0000 -20,000 1 -1,20,000 -20,000 -1,40,000 0.8696 -1,21,739 2 -1,20,000 -20,000 -1,40,000 0.7561 -1,05,860 3 -1,20,000 -10,000 -1,30,000 0.6575 -85,477 NPV ($) = -3,33,076

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