Lim Coaches needs to acquire a new coach. They have the option of leasing the new coach
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 5th 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:
Calculate the NPV of the lease proposal?
Calculate the NPV of the purchase proposal?
Recommend, based on the NPV, which option should be chosen?
Fundamentals of Corporate Finance
ISBN: 978-1259024962
6th Canadian edition
Authors: Richard Brealey, Stewart Myers, Alan Marcus, Devashis Mitra, Elizabeth Maynes, William Lim