Reference no: EM132957217
The Colour Inc. wants to upgrade its fleet of buses. The new buses can be purchased or leased from the manufacturer. The company made the following evaluation of the two alternatives:
Purchase
Cost of the buses -$680,000
Annual cost of servicing, licences, and taxes -$7,200
Repairs:
First four (4) years -$2,400
Fifth year -$4,000
Sixth year- $8,000
The buses would be sold after six (6) years. Based on the current resale values, the company would be able to sell them for about one-half of their original cost at the end of the six-year period.
Lease
If the new buses are leased, the company will need to make an immediate deposit of $40,000 to cover any damage during use. The lease will run for six (6) years, at the end of which time the deposit will be refunded. The lease will require an annual payment of $140,000, with the first payment due at the end of year 1. The annual payment will cover the cost of servicing, repairs, licencing, and taxes of the buses. At the end of the six-year period, the buses will revert to the manufacturer.
The Colour Inc.'s required rate of return is 16%.
Required:
Problem a) Determine the present value of the cash flows associated with each alternative
Problem b) Which alternative would you recommend that the company accept? Why?
Problem c) Discuss the advantages and disadvantages of each alternative.