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Homework answers / question archive / A firm urgently needs a large printer and will either lease a printer at an end-of-year cost of $ 5000 for a 6 year period, or they will purchase the printer at an initial cost of $60,000

A firm urgently needs a large printer and will either lease a printer at an end-of-year cost of $ 5000 for a 6 year period, or they will purchase the printer at an initial cost of $60,000

Finance

A firm urgently needs a large printer and will either lease a printer at an end-of-year cost of $ 5000 for a 6 year period, or they will purchase the printer at an initial cost of $60,000. If purchased, the printer will have a zero salvage value at the end of 6-years life. No other costs are to be considered. MARR is 5%. What is the best investment decision on the basis of the internal rate of return. O a. IRR could not be calculated due to no change in cashflow sign Ob. Negative IRR is not justified and is not applied here to make a proper decision Lease O d. Buy

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Calculation of Present value of cash outflow under Lease option: ( based on MARR )

PV = A * ((1+ r)n-1 ) / ( r*(1+rn)) where A represents the annual payment, r is discount rate , n is number of years.

PV = 5000 * ((1+0.05)6-1) / 0.05 * (1+0.05)6

PV =  5000 * ( 1.34-1 ) / (0.05 * 1.34)

PV = 5000 * ( 0.34 ) / ( 0.067 )

PV = 5000 * 5.0757 = $ 25378

Therefore cash outflow from Lease option is $ 25378.

Calculation of Present value of cash outflow under BUY option:

Present value of Cash Outflow is $ 60,000 ( no salvage value )

Hence the option c - Lease is the best investment decision and option d - Buy option is not preferred.

IRR of any project should be more than MARR ( hurdle rate ). In the given problem we have taken MARR as discounting rate and arrived at a conclusion that Lease option would be beneficial. If we apply IRR then the discounting rate will be more and present value of Lease payments will be even more lesser than $25378.

Hence, Option a is not correct.

Negative IRR is not justified because the firm has a MARR of 5% and we can't assume that the firm accepts an IRR lesser than MARR hence Option b is not correct.

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