Problem 3 (20 pts) . A bulldozer can be purchased for $380,000 and used for 6 ye

Question

Problem 3 (20 pts) . A bulldozer can be purchased for $380,000 and used for 6 years, when its salvage value is 15% of the first cost. Alternatively, it can be leased for $60,000 a year. (Remember that lease payments occur at the start of the year.) The firm's interest rate is 12%. a) b) c) What is the interest rate for buying versus leasing? Which is the better choice? (6 pts) What the benefits/costs ratio for bying versus leasing? Which is the better choice? (6 pts) If the firm will receive $65,000 more each year than it spends on operating and maintenance costs, should the firm obtain the bulldozer? What is the rate of return for the bulldozer using the best financing plan? (8 pts)

Explanation / Answer

what is the interest rate for buying versus leasing? which is the better choice

Salvage = 0.15 x $380,000 = $57,000 and firm’s interest rate = 12%.

NPW = 0 = –320,000 + 60,000 (P/A, IRR , 5) + 57,000 (P/A, IRR, 6) and interpolating

IRR = 3% + (0.5%)[2538/(2538 – 2730)] =3.24% (also 3.24% from Excel).

The IRR is well below the firm’s interest rate on the borrowed amount ($320,000) from leasing, so lease the bulldozer.

If the firm recieves $65000 more each year than it spends on costs, should the firm obtain the bulldozer-

NPW = 0 = –320,000 + 125,000 (P/A, IRR, 5) + 122,000 (P/F, IRR, 6) andinterpolating

IRR = 30% + (5%)[9778/(9778 – 22346)]= 31.5% (31.42% from Excel).

Now the situation has changed. the interest rate on the borrowed amount is now less than the IRR. the firm should obtain the bulldozeer now.

Year Purchase lease Purchase -lease 0 -$380,000 -$60,000 -$320,000 1 0 -$60,000 $60,000 2 0 -$60,000 $60,000 3 0 -$60,000 $60,000 4 0 -$60,000 $60,000 5 0 -$60,000 $60,000 6 $57000 0 $57000

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