Present Worth Cost Analysis and Revenues

| April 22, 2014

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A firm is considering the economics of whether to lease or purchase several small
trucks. The total purchase cost of the truck is $100,000 and they will be depreciable
over 5 years starting in time 0 with the half-year convention, using Modified ACRS
depreciation. Take a write-off on the remaining book value in the year the assets are
sold. Salvage value of the trucks is expected to total $30,000 at year 3 when the
trucks are expected to be sold. The operating, maintenance and insurance costs are
considered to be the same whether the trucks are purchased or leased so they are
left out of the analysis. The trucks can be leased for $36,000 per year on a 3-year
contract with monthly payments. To best account for the timing of the lease
payments with annual periods, assume the first 6 months of lease payments,
$18,000, are at time 0, $36,000 lease costs are at years 1 and 2 and $18,000 at year
3. The effective income tax rate is 40% and the firm has other taxable income and
tax obligation against which to use tax deductions in any year.
2-A) Use present worth cost analysis and verify the results with increment DCFROR
analysis to determine if leasing or purchasing is economically better for a minimum
DCFROR of 15%.
2-B) What uniform end-of-period annual equal revenues are required (UAERR) to
cover the cost of leasing or purchasing and give the investor a 15% DCFROR on
invested dollars?
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