A farmer is about to make a lease or buy decision about a tractor. The tractor is financed at an interest rate of 8% for seven years, with an annual payment of $10 564. The cash flows of both options for seven years and the factors taken into consideration are summarized in the table below. Also, it is assumed that there are no repair costs associated with leasing the equipment.   (a) Using net present value of cost, determine the best approach for the farmer.   Purchase   (b) Explain why fuel cost is not included in the comparison.

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
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  1. A farmer is about to make a lease or buy decision about a tractor. The tractor is

financed at an interest rate of 8% for seven years, with an annual payment of $10 564.

The cash flows of both options for seven years and the factors taken into consideration

are summarized in the table below. Also, it is assumed that there are no repair costs

associated with leasing the equipment.

 

(a) Using net present value of cost, determine the best approach for the farmer.

 

Purchase

 

(b) Explain why fuel cost is not included in the comparison.

Year
Buy option
Down payment
Repairs
Loan payment
Tax reduction
Salvage value
Lease option
Up-front charges
Lease cost
Tax reduction
Lease penalty
1
5 000
1 000
10 564
3912
3 000
7 500
2940
2
1 500
10 564
3 914
7 500
2 100
3
2 500
10 564
4 045
7 500
2 380
1 000
4
3 000
10 564
4 024
3 000
7 500
2 940
5
3 500
10 564
3 990
7 500
2 100
6
4 000
10 564
3 942
7 500
2 380
1 000
7
4 500
10 564
3 879
31 000
3 000
7 500
2 940
Transcribed Image Text:Year Buy option Down payment Repairs Loan payment Tax reduction Salvage value Lease option Up-front charges Lease cost Tax reduction Lease penalty 1 5 000 1 000 10 564 3912 3 000 7 500 2940 2 1 500 10 564 3 914 7 500 2 100 3 2 500 10 564 4 045 7 500 2 380 1 000 4 3 000 10 564 4 024 3 000 7 500 2 940 5 3 500 10 564 3 990 7 500 2 100 6 4 000 10 564 3 942 7 500 2 380 1 000 7 4 500 10 564 3 879 31 000 3 000 7 500 2 940
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