NPV Analysis of a Lease

or Buy Decision
CASE 14-39
 BUY
Acquisition Cost = $850,000

Periodic outlays for Repairs and Maintenance=

$20,000

Salvage value = $500,000

 BUY
YEAR PAYMENT PRINCIPAL INTEREST BALANCE
0 850,000
Down 350,000 350,000 500,000
Pmt.
1 175,000 125,000 50,000 375,000
2 175,000 125,000 50,000 250,000
3 175,000 125,000 50,000 125,000
4 175,000 125,000 50,000 -----
$1,050,000 $850,000 $200,000
 BUY Timeline

0 1–4 5 – 17 18

-Down (350,000)

Payment

-Property Tax, etc. (20,000) (20,000) (20,000)

-Amortization (175,000)

-Salvage value 500,000

(195,000) (20,000) 480,000

 LEASE
Annual Lease pmt. = $120,000 (annuity due)

Security Deposit = $8,000

Repairs & Maintenance = $4,500

RRR = 16%

N = 18
 NPV Cost to Lease

0 1 – 17 18
-SECURITY (8,000) 8,000

DEPOSIT

-LEASE PMT. (120,000) (120,000)

-REPAIRS (4,500) (4,500)

& MAINTENANCE

(128,000) (124,500) 3,500

 BUY vs. LEASE
BUY
Cash flow Amount Period Factor NPV

Initial
(350,000) Now 1.000 (350,000)
Investment
Repairs &
20,000 1 - 18 5.818 (116,360)
Maintenance
Loan
(175,000) 1-4 2.798 (489,650)
Payments

Salvage Value 500,000 18 0.069 34,500

PV Cost to
($921,510)
Buy
 BUY vs. LEASE
LEASE
Cash flow Amount Period Factor NPV
Annual Lease
(120,000) 0 - 17 6.749 (809,880)
Payments
Repairs &
(4,500) 1 - 18 5.818 (26,181)
Maintenance
Security
(8,000) Now 1.000 (8,000)
Deposit

Recovery 8,000 18 0.069 552

PV Cost to
($843,509)
Lease
 REPLY on the issue
Sam Watkins was right when he considered the residual value of
the property at the end of the project as a cash inflow in making
Capital Budgeting Decisions. But in assessing the cost of
‘buying’, Sam did not consider discounting the figures.

In making Capital Budgeting Decisions, one must account for the

time value of money especially when it extends for many years
and in comparing lease or buy options.

Top Quality Stores, Inc. requires a minimum return of 16% for a

project to be accepted. To determine whether such project will
earn higher than the hurdle rate, all cash flows will have to be
discounted at its Present value to facilitate comparison with
cash flows for a long investment horizon.