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Question:

Lim Coaches needs to acquire a new coach. They have the option of leasing the new coach or buying it outright.

The lease proposal involves:

A five year lease

Payments of $100,000 at the beginning of each year

A final residual payment at the end of the 5^th year of $500,000

No residual value for depreciation calculations

A possible resale value, if sold after 5 years, of $200,000

If the company chooses to buy the coach, it involves:

An initial cost of $800,000

Depreciation, on a straight line basis over 5 years

No residual for depreciation calculations

A possible resale value after 5 years of $200,000

The cost of the coach will be finance with a deposit of 20% by the company and the balance financed with an interest only loan at 10%

Interest is payable at the end of each year

The loan principal is repaid at the end of 5 years

Other information relevant to the decision:

Company tax of 30% is payable at the end of each year

Cost of capital is 10% per annum

The coach will be sold at the end of 5 years, regardless of which option is chosen

Required:

1. Calculate the NPV of the lease proposal
2. Calculate the NPV of the purchase proposal

My answer:

1. Lease 1 2 3 4 5 Instalments -100000 -100000 -100000 -100000 -100000 Tax - instalments 30000 30000 30000 30000 30000 Residual -500000 Disposal 200000 Tax - disposal 90000 -100000 -70000 -70000 -70000 -70000 -180000 i=10% NPV= -433656 2. Purchase 1 2 3 4 5 Deposit -160000 Purchase -640000 Loan 640000 Interest -64000 -64000 -64000 -64000 -64000 Tax - interest 19200 19200 19200 19200 19200 Repay -640000 Tax - depreciation 48000 48000 48000 48000 48000 Disposal 200000 Tax - disposal -60000 -160000 3200 3200 3200 3200 -496800 i=10% NPV= -458330