Foster Inc. is trying to decide whether to lease or purchase a piece of equipmen

Question

Foster Inc. is trying to decide whether to lease or purchase a piece of equipment needed for the next ten years. The equipment would cost $48,000 to purchase, and maintenance costs would be $5.300 per year After ten years, Foster estimates it could sell the equipment for $28,000. If Foster leases the equipment, it would pay $16,000 each year, which would include all maintenance costs. (Future Value of $1. Present Value of $1. Future Value Annuity of $1, Present Value Annuity of $1.) If the hurdle rate for Foster is 12%, Foster should (Round your PV factors to 4 decimal places. Do not round intermediate calculations. Round your final answer to the nearest hundred) O lease the equipment, as net present value of cost is about $21,500 less. O buy the equipment, as net present value of cost is about $21,500 less O lease the equipment, as net present value of cost is about $17,800 less. O buy the equipment, as net present value of cost is about $48.000 less. O Type here to search F1 F2 1 2 3 4

Explanation / Answer

Answer - B

Purchase of Equipment

Initial cash outflow = $48,000

Maintenance cost = $5,300 per year

Salvage value = $28,000

Life = 10 Years

Cost of capital = 12%

PVAF@12% for 10 Years = 5.65

PVF@12% of 10th year = 0.322

Present value of cash Outflows = Initial cash outflow + (Yearly Maintenance Cost * PVAF@12% for 10 Years) – (Salvage value * PVF@12% of 10th year)

= $48,000 + ($5,300 * 5.65) – ($28,000*0.322)

Present value of cash Outflows =$68,929

Lease of Equipment

Cash outflow per year = $16,000

Present value of cash Outflows = (Cash outflow per year * PVAF@12% for 10 Years)

= ($16,000 * 5.65)

Present value of cash Outflows = $90,400

Difference = 90,400 – 68,929 = 21,471

It is recommended to buy the equipment as the cost is about $21,500 less in compare to leasing.

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