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Emerson Corp
Emerson Corp. is trying to decide whether to lease or purchase a piece of equipment needed for the next five years. The equipment would cost $506,000 to purchase, and maintenance costs would be $21,800 per year. After five years, Emerson estimates it could sell the equipment for $101,700. If Emerson leases the equipment, it would pay $151,700 each year, which would include all maintenance costs. Emerson's hurdle rate is 12%. (Future Value of $1, Present Value of $1, Future Value Annuity of $1, Present Value Annuity of $1.) (Use appropriate factor from the PV tables.) a. What is the net present value of the cost of purchasing the equipment? (Round your final answer to the nearest dollar amount.) Net Present Value b. What is the net present value of the cost of leasing the equipment? (Round your final answer to the nearest dollar amount.) Net Present Value c. Based on financial factors, should Emerson purchase or lease the equipment? Purchase Lease
Expert Solution
Present value of cost of purchasing equipment:
Cost of Equipment = $506,000
Maintenance cost = $21,800 per year for 5 years
Sale value of equipment after five years = 101700
Hurdle rate = 12%
Present value of cost of purchasing equipment = Cost of Equipment + Present value of maintenance cost - Present value of sale value of equipment after five years
Present value of maintenance cost = 21800*Present value annuity factor(12%,5)
= 21800*3.60478 = $78584
Present value of sale value of equipment after five years = 101700*Present value interest factor (12%,5)
= 101700*0.56743 = $57708
Present value of cost of purchasing equipment = 506000 + 78584 - 57708 = 526,876
Net present value of cost of purchasing equipment = $526,876
b)
Lease rent each year = 151,700
Present value of lease rent = 151,700*Present value annuity factor (12%,5)
= 151,700*3.60478 = 546,845
Net present value of the cost of leasing the equipment = $546,845
c)
Purchase
Emerson should purchase the equipment as the net present value of the cost of purchase is lower in comparison to cost of leasing.
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