My Courses My Notifications Content Collection Question 13 10 out of 10 points 1

Question

My Courses My Notifications Content Collection Question 13 10 out of 10 points 1 A company has to make a choice Choice 1 is to lease a warehouse for 10 years at an initial payment of 100,000 Dhs now and make annual lease payments of 30,000 Dhs Ater 10 years it can return the warehouse by paying 10,000 Dhs painting and decoration costs Choice 2 is to buy the warehouse now for 200,000 Dhs It will need a maintenance contract for which it will pay 5,000 Dhs per yoar At the end of the 10 years the warehouse can be sold for 40,000 Dhs Assur ing an i terest rate of 12% should the company lease or un PW method hemarehouse? Show all calculations supporting your decision Use Question Cost of Leasing Cost of Buying Will you buy or Lease

Explanation / Answer

Cost for Leasing

Initial Payment = 100000, Annual Lease payment = 30000, Tenure = 10 years, Painting & Decoration Cost at the end of tenure = 10000

PV of lease payment can be calculated using PV of Annuity formula:

PV = C * ((1-1/(1+r)T)/r) where, C = Periodic payment, r = Periodic Interest Rate & T = Tenure

Here, C = 30000, r = 12% & T = 10 years

So, PV of total lease payments = 30000 * ((1-1/(1+12%)10)/12%) = 169506.69 [rounded to 2 decimals]

PV of Painting & Decoration Cost at the end of tenure = 10000/(1+12%)10 = 3219.73   [rounded to 2 decimals]

So, PV of Total Cost for Leasing = 100000 + 169506.69 + 3219.73 = 272726.42 Dhs

Cost for Buying

Buying Price = 200000, Annual Maintenance payment = 5000, Tenure = 10 years, Resale Value at the end of 10 years = 40000

PV of maintenance payment can be calculated using PV of Annuity formula:

PV = C * ((1-1/(1+r)T)/r) where, C = Periodic payment, r = Periodic Interest Rate & T = Tenure

Here, C = 5000, r = 12% & T = 10 years

So, PV of total maintenace payments = 5000 * ((1-1/(1+12%)10)/12%) = 28251.12   [rounded to 2 decimals]

PV of Resale Value at the end of 10 years = 40000/(1+12%)10 = 12878.93   [rounded to 2 decimals]

So, PV of Total Cost for Buying = 200000 + 28251.12 - 12878.93 = 215372.19 Dhs

As the PV of Cost of Buying is less than the PV of Cost of Leasing, Company should choose Choice 2 i.e. Buying.

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