LBCC Bike Shop needs to obtain a gear-cutting machine, which can be purchased fo
ID: 2525817 • Letter: L
Question
LBCC Bike Shop needs to obtain a gear-cutting machine, which can be purchased for $75,000. LBCC Bike Shop estimates that repair, maintenance, insurance, and property tax expense will be $20,000 for the machine’s five-year life. At the end of the machine’s life, it will have no salvage value.
As an alternative, LBCC Bike Shop can lease the machine for five years for $18,000 per year. If the machine is leased, LBCC Bike Shop is required to pay only for routine maintenance on the machine, which is estimated to be $8,000 over the machine’s life. All other costs will be paid by the lessor. Should LBCC Bike Shop purchase or lease the machine.
Explanation / Answer
Total Cost of Purchase over five year life = Purchase Cost+Repairs, Maintenance, Taxes etc.
= $75,000+$20,000 = $95,000
Total Cost of lease over five years = Total lease payments+Routine Maintanance
= (Annual Lease Payments*5 years)+$8,000
= ($18,000*5)+$8,000 = $90,000+$8,000 = $98,000
The cost of purchase of machine of $95,000 is less than the total cost of lease of $98,000 over the machine life of five years. Therefore LBCC Bike Shop should purchase the machine. (i.e. the option with minimum cash outflow should be choosed).
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