Question:
Trasky Company is trying to decide whether it should lease or purchase a new automated machine to be used in the production of a new product. If purchased, the new machine would cost $100,000 and would be used for ten years. The salvage value at the end of 10 years is estimated at $20,000. The machine would be depreciated using straight line depreciation over a 7 year period. The annual maintenance and operating costs would be $20,000. Annual revenues are evaluated at $55,000.
If the machine is leased, the company would need to pay annual lease payments of $20,700. The first lease payment and a deposit of $5,000 are due instantly. The last lease payment is paid at the starting of Year 10. The deposit is refundable at the end of the tenth year. In additional, under a normal contract, the company must pay for all maintenance and operating costs, though the leasing company does offer a service contract that will provide annual maintenance (on leased machines only). The contract must be paid up front and costs $30,000. Trasky estimates that the contract can reduce its annual maintenance and operating costs by $10,000. Trasky's cost of capital is 14%. The tax rate is 40%. The service contract's costs could be expensed over the 10 year period. Assume this is an operating lease.
a. Determine the NPV for the purchase, lease without the service contract, and the lease with the service contract.
b. Which is the best alternative?