Executive Summary:
Capital budgeting investment decisions are very important in any organization. These decisions involve assessing many factors in order to determine which projects are appropriate for the company to pursue. Equipment is required in order to run a business. Although it is not necessary to purchase each and every item, significant decisions must be made to determine whether to buy or lease items. The advantages and disadvantages of buying and leasing must be considered in order to come to a conclusion. Acme Iron is considering leasing a new computer. We completed an in-depth analysis to determine should Acme Iron lease or purchase the equipment. After completing calculations for NPV, we determined that it is cheaper to lease than to purchase as the NPV of lease is lower than that of Purchase.
Analysis:
What is the after-tax cash flow from leasing relative to the after-tax cash flow from purchasing in years 1-9?
For years 1-9:
After-tax cash flow leasing: (-10,000)(1-0.3) = -$7,000
After-tax cash flow purchasing:
Depreciation = $70,650/9 = $7,850 per year
After tax depreciation = $7,850*(1 - 0.3) = $5,495
Add back depreciation: $5,495 + $7,850 = $13,345
What is the after-tax cash flow from leasing relative to the after-tax cash flow from purchasing in year 0?
The after tax cash flow for leasing is -$10,000.00 and the after tax cash flow for purchasing would equal.= $70,650 - $10,000(1 - .30) = $63,650
What is the NPV of the lease relative to the purchase?
To find the NPV, we simply use the cash flows and the discount rate of 8%:
For leasing: - $10,000 + -$70,000/(1.08) + $70,000/(1.08^2) + ... $7,000/(1.08^9)
NPV of lease: -$53,728.22
For purchasing: -$70,650 + $13,345/1.08 + $13,345/(1.08^2) + ... $13,345/(1.08^9)
NPV of purchase: $12,714
What would the after-tax cash flow in year 9 be if the asset had a residual value of $500 (ignoring any possible risk differences)?
After-tax cash flow in year 9 with residual value of $500:
Depreciation = ($70,650 - $500)/ 9 = $7,794.44
$8,294.44(1-0.3) + $7,794.44 = $13,600.55
Do you have a recommendation?
Considering that the NPV results are favorable for the project, it is recommended that investment in the project is valuable.