For long distance transport of your expensive electronic products your company i
ID: 2739430 • Letter: F
Question
For long distance transport of your expensive electronic products your company is leasinga cargo-plane for $150,000 per year. Your annual costs depend on the miles of flights andthey are directly proportional to them at a cost of $5 per mile.
You have received an offer to purchase an airplane
- Initial investment of $1,000,000.
- The lifespan of the airplane is 8 years at which time it can be scrapped for $150,000.
- At 5 years a major maintenance of cost $150,000 will be required. Obviously at the end you do not have to perform maintenance.
- Due to its technological improvements the cost per mile is $4.6.
Evaluate the proposed offer using the net present value for an indicative annual mileage of 120,000 miles.
What is the Internal Rate of Return of the purchase versus the continuation of the lease? Do you recommend it? The discount interest rate (MARR) for the evaluation of the investments is set to 4%.
Explanation / Answer
Leasing alternative:
Total cost per year (from year 1 to 5) = {[$150,000 + (120,000 * $5)]} * 5
= $3,750,000
Total cost per year (from year 6 to 8) = {[$150,000 + (120,000 * $4.6)]} * 3
= $2,106,000
Now,
Present value of leasing alternative = Total cost per year upto 5 years * PV of anuuity (i= 4%, n = 5) + Total cost per year from 6 to 8 years * PV of anuuity (i= 4%, n = 3)
= ($3,750,000 * 4.451822) + ($2,106,000 * 2.280922)
= $21,497,954.23
Buying alternative:
Year
Cash flow
PV of annuity factor
PV cash flows
0
$ 1,000,000.00
1.000000
$ 1,000,000.00
1-5
$ 3,750,000.00
4.451822
$ 16,694,332.50
5
$ 150,000.00
0.821927
$ 123,289.05
6-8
$ 2,106,000.00
2.280922
$ 4,803,621.73
8
$ (150,000.00)
0.730690
$ (109,603.50)
$ 22,511,639.78
Buying option is little expensive than leasing option. In leasing option PV of cash outflow is $21.49 million where in buying option it is $22,51 million. Therefore, it is recommended to lease the cargo plane.
Year
Cash flow
PV of annuity factor
PV cash flows
0
$ 1,000,000.00
1.000000
$ 1,000,000.00
1-5
$ 3,750,000.00
4.451822
$ 16,694,332.50
5
$ 150,000.00
0.821927
$ 123,289.05
6-8
$ 2,106,000.00
2.280922
$ 4,803,621.73
8
$ (150,000.00)
0.730690
$ (109,603.50)
$ 22,511,639.78
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.