please help me with the following analysis, thankyou!

An electronic store claims:
'if you pay more than £100 a year leasing a washing machine it is a
better deal to buy from us than lease'.
The company advert specifies:
 4 years guarantee and a part-exchange of £200 for another machine
after these 4 years.
e.g. Hotpoint WF860: £ 600
less part exchange value £200
= £400. Over 4 years = £100 a year.
"You will see these figures are favourable with current market rent charges"

The question is, using finance principles (e.g. NPV) is this advert misleading?

Assumptions: You have personal savings earning 8% interest(say £600)
             Inflation 2%
             Personal Tax rate 25%
             (No part exchange unless you buy another machine)

Please decide, using NPV calculations, whether it is better to lease
or buy and therefore whether or not the advert is misleading.

Also how sensitive is the analysis with respect to the assumptions set out above?

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Request for Question Clarification by endo-ga on 21 Jan 2006 15:26 PST

Hi,

Which part do you need help with? Are there specific things you don't understand?
Do you understand what NPV is?
Do you have a financial calculator?

Thanks.
endo

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Clarification of Question by timidacademic-ga on 22 Jan 2006 02:03 PST

Well im not sure how to handle the lease v buy analysis (highest npv)
because usually it is a comparison of 'loan to purchase'vs lease
rather than use already existing funds to purchase. I know how to
calculate the discount rate, however the part exchange is also
confusing me. Also not sure if i use a depreciation schedule in this
scenario
I have excel for financial modelling

Thanks

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Request for Question Clarification by endo-ga on 22 Jan 2006 03:58 PST

Hi,

If I understand the question correctly, you need to compare the NPV of
all your cash flows over 4 and/or 8 years.

So you buy a new machine, that will cost you £600 outright. Over which
you will not earn any interest (that's where the personal savings bit
comes in).

Now compare that to the NPV of paying £100 a year. Taking into account
that you will earn interest on your savings and pay tax on that
interest.

I believe your discount rate is the interest you earn on your savings
minus inflation.

Do the same taking into account the part exchange and getting the machine at £400.

You can guess the answer from the way the question is asked.

If you need anymore help, please let me know. The reason I'm not just
giving you the answer, is that we're not allowed to do your homework,
but we can give pointers.

Thanks.
endo

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Clarification of Question by timidacademic-ga on 22 Jan 2006 10:53 PST

wouldnt the £400 part exchange value be subject to inflation afer 4
years? I think im going to purchase a specialist lease v buy analyser
to help me!

Many thanks

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Request for Question Clarification by endo-ga on 22 Jan 2006 12:00 PST

Yes it would be subject to inflation.
Just calculate the NPV for £100 a year versus £400 now and versus £600 now.

The question is trying to make you understand that £100 a year is not
the same as £400 now and especially not the same as £600 now.

Thanks.
endo

Since most washing machines (at least those in the U.S.) can go a
decade or more before needing repair buying is always the better bet.
You can always sell a used washer if it comes to that and get back
some of the purchase price.

It's a homework question, so it has nothing to do with real washing machines :)
endo