The Capitalpoor Company is considering purchasing a business machine for $100,00

Question

The Capitalpoor Company is considering purchasing a business machine for $100,000. An alternative is to rent it for $35,000 at the beginning of each year. The rental would include all repairs and service. If the machine is purchased, a comparable repair and service contract can be obtained for $1,000 per year. The salesperson of the business machine firm has indicated that the expected useful service life of this machine is five years, with zero market value, but the company is not sure how long the machine will actually be needed. If the machine is rented, the company can cancel the lease at the end of any year. Assuming an income tax rate of 25%, a straight-line depreciation charge of $20,000 for each year the machine is kept, and an after-tax MARR of 10%, prepare an appropriate analysis to help the firm decide whether it is more desirable to purchase or rent.

Explanation / Answer

As the total cost of buiying the asset is lesset than renting it, the asset must be bought.

cost of new machine       100,000 repair            1,000 per year userful life                    5 years Deprecation          20,000 Tax saving            5,000 after tax dep          15,000 annual maintenance            1,000          16,000 PVAF(10%, 5 yrs) 3.79078 Total expense    60,652.48 Rent          35,000 per year tax saving            8,750 After tax rent          26,250 PVAF(10%, 5 yrs) 3.79078 total expense    99,507.98

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