Case Analysis 2: Lease or buy Analysis A petroleum engineer has identified a die

Question

Case Analysis 2: Lease or buy Analysis A petroleum engineer has identified a diesel-powered generators to be either a) purchased or b) leased for an offshore platform. For the purchase scenario, the initial cost is $150,000, annual operation cost is $9,000 per year, the number of operational years is 4 and the salvage value after selling the generator at the end of year 4 is $30,000 He approached the manufacturer with concerns that the first cost was too high and the expected life too short. He was offered a lease arrangement for 6 years with a $30,000 annual cost and an extra $10,000 payment in the first and last years to cover installation and removal costs. a) Determine if the purchase or lease arrangement is better at 12% per year by using LCM Method and then study period of 3 Years, assuming the same salvage value. b) Recommend and use any other short method of comparison for different lives.

Explanation / Answer

As the life of the Project is Different we have to take LCM So we analysis Project on basis of 12Year which is LCM Period 4 Years Case A : Purchase Initial Cost $150,000 Annual Operationg Cost $9,000 Salvage Value $30,000 Year Amount PV Factor@12% NPV 0 150000 1 150000 1 9000 0.893 8037 2 9000 0.797 7173 3 9000 0.712 6408 4 -21000 0.635 -13335 5 159000 0.567 90153 6 9000 0.507 4563 7 9000 0.452 4068 8 -21000 0.404 -8484 9 159000 0.361 57399 10 9000 0.322 2898 11 9000 0.287 2583 12 -21000 0.257 -5397 Total 306066 Case B : Lease Initial Cost $0 Annual Operationg Cost $30,000 Extra Cost 1 $10,000 6 $10,000 Year Amount PV Factor@12% NPV 0 0 1 0 1 40000 0.893 35720 2 30000 0.797 23910 3 30000 0.712 21360 4 30000 0.635 19050 5 30000 0.567 17010 6 40000 0.507 20280 7 40000 0.452 18080 8 30000 0.404 12120 9 30000 0.361 10830 10 30000 0.322 9660 11 30000 0.287 8610 12 40000 0.257 10280 Total 206910 As per above calcultion Lease is better option Period 3 Years Case A : Purchase Initial Cost $150,000 Annual Operationg Cost $9,000 Salvage Value $30,000 Year Amount PV Factor@12% NPV 0 150000 1 150000 1 9000 0.893 8037 2 9000 0.797 7173 3 -21000 0.712 -14952 4 150000 0.635 95250 4 9000 0.635 5715 5 9000 0.567 5103 6 -21000 0.507 -10647 Total 245679 Case B : Lease Initial Cost $0 Annual Operationg Cost $30,000 Salvage Value $0 Extra Cost 1 $10,000 6 $10,000 Year Amount PV Factor@12% NPV 0 0 1 0 1 40000 0.893 35720 2 30000 0.797 23910 3 30000 0.712 21360 4 30000 0.635 19050 5 30000 0.567 17010 6 40000 0.507 20280 Total 137330 As per above calcultion Lease is better option As the life of the Project is Different we have to take LCM So we analysis Project on basis of 12Year which is LCM Period 4 Years Case A : Purchase Initial Cost $150,000 Annual Operationg Cost $9,000 Salvage Value $30,000 Year Amount PV Factor@12% NPV 0 150000 1 150000 1 9000 0.893 8037 2 9000 0.797 7173 3 9000 0.712 6408 4 -21000 0.635 -13335 5 159000 0.567 90153 6 9000 0.507 4563 7 9000 0.452 4068 8 -21000 0.404 -8484 9 159000 0.361 57399 10 9000 0.322 2898 11 9000 0.287 2583 12 -21000 0.257 -5397 Total 306066 Case B : Lease Initial Cost $0 Annual Operationg Cost $30,000 Extra Cost 1 $10,000 6 $10,000 Year Amount PV Factor@12% NPV 0 0 1 0 1 40000 0.893 35720 2 30000 0.797 23910 3 30000 0.712 21360 4 30000 0.635 19050 5 30000 0.567 17010 6 40000 0.507 20280 7 40000 0.452 18080 8 30000 0.404 12120 9 30000 0.361 10830 10 30000 0.322 9660 11 30000 0.287 8610 12 40000 0.257 10280 Total 206910 As per above calcultion Lease is better option Period 3 Years Case A : Purchase Initial Cost $150,000 Annual Operationg Cost $9,000 Salvage Value $30,000 Year Amount PV Factor@12% NPV 0 150000 1 150000 1 9000 0.893 8037 2 9000 0.797 7173 3 -21000 0.712 -14952 4 150000 0.635 95250 4 9000 0.635 5715 5 9000 0.567 5103 6 -21000 0.507 -10647 Total 245679 Case B : Lease Initial Cost $0 Annual Operationg Cost $30,000 Salvage Value $0 Extra Cost 1 $10,000 6 $10,000 Year Amount PV Factor@12% NPV 0 0 1 0 1 40000 0.893 35720 2 30000 0.797 23910 3 30000 0.712 21360 4 30000 0.635 19050 5 30000 0.567 17010 6 40000 0.507 20280 Total 137330 As per above calcultion Lease is better option

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