Stainless Steel Systems (SSS) makes industrial scrubbers. In these cash tight times, SSS gives its customer the options to lease their scrubbers or to purchase them through a SSS finance plan. A 36-month lease on a $20,000 scrubber would have monthly charges of $475 to their customer.
At the end of the lease, the scrubber is returned to SSS. For the SSS finance plan, the same scrubber could be purchased (no initial cost) with 36 monthly uniform payments, at an interest rate of 9% (nominal yearly rate) to SSS.
Three year old scrubbers can almost always be resold for about half of their purchase price. Keep in mind that usually SSS customers can invest their cash somewhere else at some interest rate rather than sinking that money into scrubbers.
a) What is the financed monthly payment required to purchase a scrubber?
b) What is the monthly incremental IRR between the financed monthly payment and the leased monthly payment? Think about it this way: You should find that the financed monthly payment is greater than the monthly lease payment.
Consider that difference is your monthly payment (an A) invested so that after three years you can get the salvage value (an F). Set up that incremental F/A between leasing and financing and solve for the monthly incremental IRR.
c) What is the effective annual rate earned by SSS customers who finance rather than lease?
d) Over what range of annual effective interest rates (earned by SSS customers elsewhere) would leasing be the preferred option?
e) What are at least two reasons that would make leasing a more desirable option than is indicated in part c)?