Application Problems

Suppose a firm went through a request for proposal, vendor proposals, benchmarking, and the final choice of a- system that can be purchased or leased. Under the purchase option:

   a. The price tag is $500,000.

   b. The expected useful life is five years, and the salvage value is $40,000.

   c. The vendor allows a trade-in on the user's old hardware of $100,000.The book values                                                        $70,000, and there is a remaining life of one veal'.

   d. Maintenance service is available at $8,000 per year.

    Under the lease option:

a. Lease charges are $110,000 per year under a five-year contract.

b. Lessor's (vendor) maintenance fees are $8,000 per year.

c.  There is no trade-in allowance, although a third party is offering 75,000 for the old equipment.

d. Cost of capital to the user is 10 percent, and the effective tax rate b 40 percent.

Assignment

Determine the net present value applied to the purchase/lease options. Keep in the following:

a. The benefits derived from either option are assumed to be equal.

b. When using the net present value method, you are looking for the net present value of either cash inflows or cash outflows.

 c. Show all cash inflows and outflows net of their tax effect.

 d. Proceeds from the sale of the old system are reduced by the tax on the gain from the sale.

 e. Tax benefits that result from the deductibility of the service contract, the payments and depreciation are taken into account in the analysis. The effect is a reduction in the cash outflows related to the expenditures.

 f. Maintenance, lease payments, and depreciation are annuities, fixed amounts payable over a period of time.