Calculate the lease payments net of tax then pvif and npv

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Reference no: EM133665217

Problem

PTGC Ltd has been awarded the contract to carry out a residential subdivision installation and need an additional compressor for an estimated nine months. The purchase price of the compressor is $56,000 and it is estimated that it can be sold at the end of the period for $40,000.

Should the company decide to buy the compressor, it would be required to pay an annual insurance premium of $3,000; one quarter will be recoverable at the end of the nine months. In addition, maintenance costing $300 will have to be carried out at the end of each month, except for the ninth month when a major overhaul costing $1,000 is needed to prepare it for sale.
The company has been offered an operating lease of the same compressor by Hedley Leasing Ltd at monthly rentals of $3,300 payable in advance.

The company tax rate is 30% and PTGC Ltd can borrow at an after tax rate of 12% per annum.
Assume that tax savings are obtained immediately except for depreciation, in which case savings are obtained at the end of the ninth month.

Your manager expects you to use the following approach to formulate your advice. Remember all workings are to be provided to the client as per SFBAG policies and procedures.

A. Buy option: consider all costs associated with this choice, take note of the sale proceeds and tax on the proceeds. Calculate the net cash flows over the period, Calculate the Present Value Interest Factor (PVIF), then calculate the Net Present Value (NPV).

B. Lease option: Calculate the Lease payments net of tax, then PVIF and NPV.

C. Explain the concept of discounted cash flow techniques for project evaluation. You should comment on the two main methods and the criteria used to accept or reject an investment opportunity.

D. Using the discounting cash flow method advise PTGC Ltd on whether to buy or lease the compressor.

Reference no: EM133665217

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