Brinsley Transport wants to upgrade its fleet of highway transport trucks. The new trucks that the company wants to acquire can be either purchased or leased from the manufacturer. The company has made the following evaluation of the two alternatives: Purchase alternative. If the new transport trucks are purchased, then the costs incurred by the company will be as follows:

Purchase cost of the trucks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $680,000

Annual cost of servicing, licences, and taxes . . . . . . . . . . . . . . . $ 7,200

Repairs:

First four years, per year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,400

Fifth year. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 4,000

Sixth year. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 8,000

The trucks would be sold after six years. Based on current resale values, the company would be able to sell them for about one-half of their original cost at the end of the six-year period. Lease alternative. If the new transport trucks are leased, then the company will have to make an immediate deposit of $40,000 to cover any damage during use. The lease will run for six years, at the end of which time the deposit will be refunded. The lease will require an annual rental payment of $140,000 (the first payment is due at the end of year 1). As part of this lease cost, the manufacturer will provide all servicing and re- pairs, license the trucks, and pay all taxes. At the end of the six-year period, the trucks will revert to the manufacturer, as owner. Brinsley Transport’s required rate of return is 16%.

Required:

Ignore income taxes.

1. Use the total-cost approach to determine the present value of the cash flows associated with each alternative.

2. Which alternative would you recommend that the company accept? Why?