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- This topic has 3 replies, 2 voices, and was last updated 3 months ago by LMR1006.

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- February 28, 2024 at 4:57 pm #701388
hello

how do you calculate lease and buy for this question:

– Asset has a five-year economic life. It can be purchased for $81,000 payable immediately and will have a residual value of $40,000 after 5 years. Alternatively it can be leased with 5 lease rentals of $14,000 per year payable annually in arrears.

The appropriate discount rate is 10% per year.

Identify how the company should finance each asset.Thank you in advance.

February 28, 2024 at 9:34 pm #701405To calculate whether the company should lease or buy the asset, we need to compare the present value of the cash flows for each option.

For the lease option, we have 5 lease rentals of $14,000 per year payable annually in arrears. To calculate the present value of these lease rentals, we discount each payment back to the present using the appropriate discount rate of 10% per year.

For the buy option, we have an upfront cost of $81,000 to purchase the asset immediately. We also have a residual value of $40,000 after 5 years. To calculate the present value of these cash flows, we discount the upfront cost and the residual value back to the present using the appropriate discount rate of 10% per year.

After calculating the present value of the cash flows for both options, we compare them. If the present value of the lease option is lower than the present value of the buy option, then the company should lease the asset. If the present value of the buy option is lower, then the company should buy the asset.

February 29, 2024 at 10:08 am #701442yes, I got that part of calculating for the buy option and choosing the lower option between buy or lease

but my main concern is for lease which years are we supposed to discount years 2-6 or years 1-5 and why?February 29, 2024 at 12:17 pm #701459Lease in arrears means that the lease payments are made at the end of each period. In this case, the lease rentals of $14,000 per year are payable annually in arrears, which means that the company makes the lease payment at the end of each year.

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