Company that is about to acquire an item of plant.
- A 5 year-operating lease with annual payments in advance of $15,000.
- Included in the lease cost is a maintenance warrantee for the term of the lease.
- Insurance of the plant are the responsibility of the lessee. The annual cost of insurance is estimated at $1,200 per year.
- The company tax rate is 35% and the company's cost of capital is 12%.
- The bank has indicated that they will charge 8% on moneys borrowed.
- Under the purchase option, the plant will be depreciated straight line over five years with an estimated residual value equal to 25% of the original cost. Assume the plant is sold at the end of 5 years.
- The market price of the plant is $70,000.
- An initial deposit of 20% is required for the purchase option.
- Assume annual compounding with instalment on the purchase option in arrears
- Assume that tax is paid or received in the same year of the transaction or event.
- The plant comes with a 3 year manufacturer's warrantee after which it will cost the company an annual maintenance charge of $2,500 paid in advance.
a) Calculate the net present value (NPV) for the lease and purchase option and make a recommendation as to which alternative is best. (Show workings)