LEASE OR BUY

 in a contractual arrangement in which a company

(the lessee) obtains an asset from another company
(the lessor) against periodic payments of lease
rentals. It may typically also involve an option to
transfer the ownership of the asset to the lessee at
the end of the lease.
Latting Corporation has entered into a 7 year lease for a building it
will use as a warehouse. The annual payment under the lease will be
$4,781. The first payment will be at the end of the current year and all
subsequent payments will be made at year-ends. What is the present
value of the lease payments if the discount rate is 6%? (Ignore income
taxes in this problem.)

A) $31,573
B) $22,257
C) $33,467
D) $26,688
 Latting Corporation has entered into a 7 year lease for a
building it will use as a warehouse. The annual payment under the
lease will be $4,781. The first payment will be at the end of the current
year and all subsequent payments will be made at year-ends. What is
the present value of the lease payments if the discount rate is 6%?
(Ignore income taxes in this problem.)

A) $31,573
B) $22,257
C) $33,467
D) $26,688
 Some decisions do not involve any revenues. For
example, a company may be trying to decide whether to
buy or lease an executive jet. In situations such as these,
where no revenues are involved, the most desirable
alternative is the one with the least total cost from a present
value perspective. Hence, these are known as least-cost
decisions.
Calculate the NPV of the cost of buying the
asset.
 Calculate the NPV of the cost of leasing the
asset.
Choose the cheaper of the two alternatives
 Let’s assume that you would like to buy a new sports car that can
be purchased for $21,495 in cash or acquired from the dealer via a
leasing arrangement. Under the terms of the lease, you would have to
make a payment of $2,078 when the lease is signed and then monthly
payments of $300 for 24 months. At the end of 24-month lease, you can
choose to buy the car you have leased for an additional payment of
$13,776. If you do not make that final payment, the car reverts to the
dealer.

Should you purchase the car or should you sign a lease with the
dealer?
 Amount of cash
Item Month(s) 1% Factor PV of cash flows
flows
Pay cash for the
car:
Cash payment - $(21,495) 1.000 $(21,495)
Net Present Value $(21,495)
Lease the car:

Cash payment on
lease signing - $(2,078) 1.000 (2,078)

Monthly lease
payment 1-24 (300) 21.243 (6,373)

Final payment 24 (13,776) 0.788 (10,855)

Net Present Value (19,306)

The leasing alternative is $2,189 less costly, in terms of net present value,
than the cash purchase alternative. Therefore, you should lease the car rather than
pay cash.
 In addition, the leasing alternative has the advantage
that you can choose to not make the final payment of $13,776
at the end of 24 months if for some reason you decide you do
not want to keep the car. For example, if the resale value of
the car at that point is far less than $13,776, you may choose
to return the car to the dealer and save the $13,776.
Problem:

The Riteway Ad Agency provides cars for its sales staff. In the
past, the company has always purchased its cars from a dealer and
then sold the cars after three years of use. The company’s present fleet
of cars is three years old and will be sold very shortly. To provide a
replacement fleet, the company is considering two alternatives:
Purchase alternative:
The company can purchase the cars, as in the past, and sell the cars after
three years of use. Ten cars will be needed, which can be purchased at a discounted
price of $17,000 each. If this alternative is accepted, the following costs will be
incurred on the fleet as a whole:

 Annual cost of servicing, taxes and licensing $3,000

 Repairs, first year. $1,500
 Repairs, second year $4,000
 Repairs, third year $6,000

At the end of three years, the fleet could be sold for one-half of the original
purchase price.
Lease alternative:

The company can lease the cars under a three-year lease

contract. The lease cost would be $55,000 per year (the first
payment due at the end of Year 1). As part of this lease cost, the
owner would provide all servicing and repairs, license the cars, and
pay all the taxes. Riteway would be required to make a $10,000
security deposit at the beginning of the lease period, which would
be refunded when the cars were returned to the owner at the end of
the lease contract.
Required: (Ignore income taxes.)

1. Determine the present value of the cash flows associated with

each alternative. (Round all dollar amounts to the nearest whole
dollar.)

2. Which alternative should the company accept?

 Amount of Cash Present Value of
Item Year(s) 18%
Flows Cash Flows
Purchase
Alternative:
Purchase cost of
the cars Now $(170,000) 1.000 $(170,000)
(10 * $17,000)
Annual cost of
1-3 (3,000) 2.174 (6,522)
servicing, etc.
Repairs:
First Year 1 (1,500) 0.847 (1,271)
Second Year 2 (4,000) 0.718 (2,872)
Third Year 3 (6,000) 0.609 (3,654)
Resale value of
3 85,000 0.609 51,765
the cars
Present Value of
$(132,554)
cash flows
 Amount of Cash Present Value of
Item Year(s) 18%
flows Cash Flows
Lease
Alternative:

Security deposit Now $(10,000) 1.000 $(10,000)

Annual lease
payments 1-3 (55,000) 2.174 (119,570)

Refund of
deposit 3 10,000 0.609 6090

Present value of
cash flows $(123,480)

The company should lease the cars because this alternative has
the lower present value of cash flows.
Cedar Hill Hospital needs to expand its facilities and
desires to obtain a new building on a piece of
property adjacent to its present location. Two options
are available to Cedar Hill, as follows: (Ignore
income taxes in this problem.)
Option 1:
Buy the property, erect the building, and install the fixtures
at a total cost of $600,000. This cost would be paid off in five
installments: an immediate payment of $200,000, and a
payment of $100,000 at the end of each of the next four
years. The annual cash operating costs associated with the
new facilities are estimated to be $12,000 per year. The new
facilities would be occupied for thirteen years, and would
have a total resale value of $300,000 at the end of the 13-year
period.
Option 2:
A leasing company would buy the property and construct the new
facilities for Cedar Hill which would then be leased back to Cedar Hill
at an annual lease cost of $70,000. The lease period would run for 13
years, with each payment being due at the BEGINNING of the year.
Additionally, the company would require an immediate $10,000
security deposit, which would be returned to Cedar Hill at the end of
the 13-year period. Finally, Cedar Hill would have to pay the annual
maintenance cost of the facilities, which is estimated to be $4,000 per
year. There would be no resale value at the end of the 13-year period
under this option. The hospital uses a discount rate of 14% and the
total-cost approach to net present value analysis in evaluating its
investment decisions.
Under option 1, the present value of all cash outflows associated with buying the
property, erecting the building, and installing the fixtures is closest to:
A) $(200,000)
B) $(491,400)
C) $(600,000)
D) $(387,200)

Under option 1, the net present value of all cash flows is closest to:
A) $(456,000)
B) $(600,000)
C) $(300,000)
D) $(507,000)
Under option 1, the present value of all cash outflows associated with buying the
property, erecting the building, and installing the fixtures is closest to:
A) $(200,000)
B) $(491,400)
C) $(600,000)
D) $(387,200)

Under option 1, the net present value of all cash flows is closest to:
A) $(456,000)
B) $(600,000)
C) $(300,000)
D) $(507,000)
Under option 2, the present value of all the annual lease payments of $70,000 is
closest to:
A) $(466,200)
B) $(408,900)
C) $(483,700)
D) $(910,000)

Under option 2, the present value of all cash flows associated with maintenance costs
is closest to:
A) $(23,400)
B) $(52,000)
C) $(70,100)
D) $(4,000)
Under option 2, the present value of all the annual lease payments of $70,000 is
closest to:
A) $(466,200)
B) $(408,900)
C) $(483,700)
D) $(910,000)

Under option 2, the present value of all cash flows associated with maintenance costs
is closest to:
A) $(23,400)
B) $(52,000)
C) $(70,100)
D) $(4,000)