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 Subject: Finance decision question Category: Business and Money > Finance Asked by: thequestionmark-ga List Price: \$15.00 Posted: 11 Sep 2006 21:07 PDT Expires: 11 Oct 2006 21:07 PDT Question ID: 764366
 ```You run a financial firm where you replace your computers every 3 years. You have 500 employees, the old computers have fully depreciated and can be sold for 500 each. You have to decide (1) between new pc's for 3000 each, witha three year depreciation period and a salvage value of 500 at the end of three years, or (2) a leasing company has agreed to take away your old pc's (you receive no \$ for them) and lease you comparable pc's for 750k each year for three years, at the end of the lease the pc's have no salvage value. your cost of capital is 9% and your tax rate is 40%. Calculate the NPV of each alternative and indicate which you would choose. please show some work``` ```Hi!! - LEASE - Initial Investment = \$0 Annual lease payment = (\$750,000) Tax shields on lease = \$750,000 * 0.40 = \$300,000 Cash Flows = CFi = (\$750,000) + \$300,000 = (\$450,000) (for years i=1 to 3). CF1 CF2 CF3 NPV = CF0 + --------- + ---------- + ---------- = (1.09)^1 (1.09)^2 (1.09)^3 = (\$1,139,082.60) - BUY - Initial investment = 500 * \$3,000 = \$1,500,000 Money received for the old PC's = 500 * \$500 = \$250,000 CF0 = (\$1,250,000) Depreciation = 500 * (\$3,000 - \$500) / 3 = \$416,666,67 Tax shields on depreciation = \$416,666,67 * 0.40 = \$166,666,67 Cash Flows CFi = \$166,666,67 (for years i=1 to 2) CF3 = \$166,666,67 + \$250,000 = \$416,666.67 CF1 CF2 CF3 NPV = CF0 + --------- + ---------- + ---------- = (1.09)^1 (1.09)^2 (1.09)^3 = (\$635,071.68) The NPV of buying the PCs is higher (less negative), this means that the cost of buying is less than the cost of leasing, then you must choose the Buying option. I hope this helps you. Feel free to request for a clarification if you find something unclear. Best regards, livioflores-ga```  