EXERCISE 2: LEASING VERSUS BUYING

You have two options: to buy or to lease a video store.

Option 1: Purchase

Year
0	Cost	$300,000
1	Additional cost	80,000
1	Cash flow from operations	45,000
2	Cash flow from operations	70,000
3	Cash flow from operations	90,000
4	Cash flow from operations	105,000
5	Cash flow from operations	140,000
6	Cash flow from operations	160,000
7	Cash flow from operations	165,000
8	Cash flow from operations	170,000
9	Cash flow from operations	175,000
10	Cash flow from operations	180,000
11	Cash flow from sale of business	400,000

If you want to make 25% on your money, should you buy the video store? To answer this question, calculate the following:

1. Net present value

2. Internal rate of return

Option 2: Leasing

You can lease a video store in another town. The net yearly cash flow from operations after deducting lease payments is estimated at $45,000 (net) from year 1 to year 10.

1. If you want to make 25% on your investment, should you lease the video store?

2. Which of the two options would you choose?

1. Why are capital projects critical?