Randall Corp. is trying to decide whether to lease or purchase a piece of equipment needed for the next five years. The equipment would cost $100,000 to purchase, and maintenance costs would be $10,000 per year. After five years, Randall estimates it could sell the equipment for $30,000. If Randall leases the equipment, it would pay $30,000 each year, which would include all maintenance costs. If the hurdle rate for Randall is 12%, Randall should:

Question

Quizplus · Accepted Answer

To calculate the net present value (NPV) for both options, we need to discount the cash flows at 12% over 5 years. 
For purchasing the equipment, the initial cost is -$100,000, maintenance costs are -$10,000 per year for 5 years, and the salvage value is +$30,000. Using the formula for NPV, we have:
NPV = -$100,000 - $10,000((1-1/1.12^5)/0.12) + $30,000/1.12^5 = -$52,592.59

For leasing the equipment, the annual cost is -$30,000 for 5 years, which includes maintenance costs. Using the formula for NPV, we have:
NPV = - $30,000 ((1-1/1.12^5)/0.12) = -$134,188.44

Since the NPV for leasing is more negative, buying the equipment would be the better choice. However, the question asks for the net present value of the cost, not the net present value. To find this value, we need to take the absolute value of the NPV for each option. 
|NPV for buying| = |-$52,592.59| = $52,592.59
|NPV for leasing| = |-$134,188.44| = $134,188.44
Since the cost of leasing is lower, the best choice would be to lease the equipment. Therefore, the answer is A) lease the equipment, as net present value of cost is about $11,000 less.