A diesel generator for electrical power can be pur- chased by a remote community

Question

A diesel generator for electrical power can be pur- chased 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%. (a) What is the interest rate for buying versus 7-72 leasing? Which is the better choice? (b) The community will spend $80,000 less eaclh year for fuel and maintenance, than it currently spends on buying power. Should it obtain the generator? What is the rate of return for the generator using the best financing plan?

Explanation / Answer

Case1 Buying diesel Generator Year 0 1 2 3 4 5 6 7 8 9 10 Initial Investment on diesel generator -480000 Add Depreciation Benefit= (Initial Investment- Salvage Value)/10 43000 43000 43000 43000 43000 43000 43000 43000 43000 43000 Add Salvage Value 50000 Total Cash Flow by Buying -480000 43000 43000 43000 43000 43000 43000 43000 43000 43000 93000 Leasing Decision Year 0 1 2 3 4 5 6 7 8 9 10 Lease Payment -70000 -70000 -70000 -70000 -70000 -70000 -70000 -70000 -70000 -70000 Incremental Cash flow for buying vs leasing (Cash flow of generator- Cash flow Leasing) -410000 113000 113000 113000 113000 113000 113000 113000 113000 113000 93000 IRR using Excel function = IRR( All incremental Cash Flows) 24% Buying is better choice since IRR 24% is greater than community interest rate of 8% b) Case2 Buying diesel Generator Year 0 1 2 3 4 5 6 7 8 9 10 Initial Investment on diesel generator -480000 Add Fuel and Maintenanace Savings 80000 80000 80000 80000 80000 80000 80000 80000 80000 80000 Add Depreciation Benefit= (Initial Investment- Salvage Value)/10 43000 43000 43000 43000 43000 43000 43000 43000 43000 43000 Add Salvage Value 50000 Total Cash Flow by Buying -480000 123000 123000 123000 123000 123000 123000 123000 123000 123000 173000 Rate of Return using IRR function in excel 23% Yes it should go ahead with purchasing the generator

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.