Bugsy?s Haulers, is considering the purchase or lease of a fuel tanker.
The Purchase Option
The purchase price is R4 000 000. This will be paid off as follows:
- R2 500 000 immediately
- R1 650 000 at the end of the first year (inclusive of interest).
If the tanker is owned, the service and maintenance charges will amount to R20 000 per annum. The salvage value of the tanker at the end of the period amounts to R500 000. The company uses the straight line method of depreciation.
The Leasing Option
Alternatively, the tanker can be leased on a four year contract for R850 000 pa, with a deposit of R700 000 payable immediately and 50% refunded at end of lease period.
The after tax cost of debt is 12%. And the company tax rate is 30%
Required
1. Calculate the cost of owning and leasing using the discounted cash flow method.
2. Advise on the option to adopt, with justification.