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 $172,500 and is expected to have a $45,000 salvage value after 6 years. Alternatively, the company can lease a clamshell for only $15,000 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 $8,000 per year. If the company’s MARR is 12% 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.

The future worth when purchased is $ .

The future worth when leased is $ .

The clamshell should be .

Explanation / Answer

Future worth when purchased = $ -230,562.90

FV when leased = $-136,335.18

The clamshell should be leased.

WORKING 1

FV for year 0 is computed using the formula= FV(12%,6,,Cash flows)

FV for year 1 is computed using FV(12%,5,Cash flows)

and so on, the period reduces by 1 every year to arrive at the FV in year 6.

** Since the lease payments are at the beginning of the year, we have started the payments from end of year 0, end of year 1 and so on. The FV is computed in the same way as in alternative 1 and then summed up.

Alternative 1- Purchase Year Initial cost Salvage value Revenues Net cash flows FV 0 -172500 -172500 ($340,484.41) 1 8000 8000 $14,098.73 2 8000 8000 $12,588.15 3 8000 8000 $11,239.42 4 8000 8000 $10,035.20 5 8000 8000 $8,960.00 6 45000 8000 53000 $53,000.00 Total FV ($230,562.90)

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.