A small strip-mining coal company is trying to decide whether it should purchase

Question

A small strip-mining coal company is trying to decide whether it should purchase or lease a new clamshell. If purchased, the "shell" will cost $162,500 and is expected to have a $35,000 salvage value after 6 years. Alternatively, the company can lease a clamshell for only $11,000 per year, but the lease payment will have to be made at the beginning of each year. If the clamshell is purchased, it will be leased to other strip-mining companies whenever possible, an activity that is expected to yield revenues of $19,000 per year. If the company's MARR is 8% per year, should the clamshell be purchased or leased on the basis of a future worth analysis? Assume the annual M&O; cost is the same for both options. ook nt int The future worth when purchased is S The future worth when leased is $ The clamshell should be [purchased

Explanation / Answer

R = 8%

n = 6 years

Future worth when purchased = future worth of annual benefits + future worth of salvage value – future worth of the investment

Future worth when purchased = 19000*(1.08^6 - 1)/.08 + 35000 – 162500*1.08^6

Future worth when purchased = -$83484.4

Future worth when leased = Future value of the lease cost

Future worth when leased = (11000*(1.08^6 - 1)/.08)*1.08 = $87150.84 (it is negative since it is a cost)

Since, the future worth of the cost is lower when the purchase of clamshell takes place than that of lease, then clamshell should be purchased.

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