Present value of both new purchase option and lease option

Assignment Help Financial Management
Reference no: EM132028583

Jones Manufacturing Co. produces personal fitness machines. After five years, the once successful line is no longer selling well, so the company is considering production of an improved line of machines incorporating new computer technology. This can be done by buying needed production equipment. There is a six-month manufacturing, delivery, setup, and training delay before the equipment will be ready for production. The company wants to start producing the new line of fitness machines in January next year. Two options are available – lease or buy. Buy Option – The entire purchase price of the production equipment is $700K and is due at the time of the order. The cost of capital for this purchase is 8%. Assume: (1) the equipment has no residual value at the end of the fifth year and (2) there are no taxes. Lease Option – The total lease cost is $600K. A $50K deposit is due at the time of the order. The remaining portion of the first year’s lease payment ($70K) is due in January next year. The other four annual lease payments ($120K each) are due in January of production years 2, 3, 4, and 5. The cost of capital for leasing is 18%. Assume no taxes. Revenue from sales of the new line of fitness machines is expected to be:

• Year 1 - $600,000

• Year 2 – $500,000

• Year 3 – $300,000

• Year 4 – $200,000

• Year 5 – $100,000

1. Calculate the net present value of both the new purchase option and the lease option. Show all work. Determine the best option for Jones and justify your answer.

2. You used the Excel NPV function with the correct discount rates to calculate NPV and you got the following values: Buy – $682,814; Lease - $689,947. What did you do wrong?

3. Calculate IRR for each option.

4. Assuming projected inflows and outflows are accurate, under what conditions can Jones expect to see a return equal to IRR? Is this realistic?

Reference no: EM132028583

Questions Cloud

What would the required return on stock with beta : If the market risk premium is 4%, and the risk-free rate is 2.2%, what would the required return on a stock with a beta of 1.3?
Total inventory management costs of cheese inventory : The company is using Economic Order Quantity model in placing the orders. What is the annual total inventory management costs of cheese inventory.
What is equivalent EVM Schedule Variance-Cost Variance : What is the equivalent EVM Schedule Variance (SV), Schedule Performance Index (SPI), Cost Variance (CV), and Cost Performance Index (CPI)?
Where there is small probability of high annual inflation : Your company is considering investing in a country that usually has manageable inflation, but where there is a small probability of high annual inflation
Present value of both new purchase option and lease option : Calculate the net present value of both the new purchase option and the lease option.
Determine the range of the interest rate : Determine the range of the interest rate i for which the present value of Option 1 is less than the present value of Option 2.
Future retirement income and expense projections : Peter and Blair recently reviewed their future retirement income and expense projections.
Find the time-weighted yield rate : Deposits of $1000 are made at the beginning of each year for three years. Find the time-weighted yield rate.
Determine the interest portion of the third payment : The annual effective rate of interest is 6%. Determine the interest portion of the third payment.

Reviews

Write a Review

Financial Management Questions & Answers

  Foreign company acquisition

Acquisition by a foreign company and the effects of that decision and the results of foreign exchange in Euro and the exchange rate differences.

  Financial management for profit and non profit organizations

In this essay, we are going to discuss the issues of financial management in a non-profit organisation.

  Method for estimating a venture''s value

Evaluate venture's present value, cash and surplus cash and basic venture capital.

  Replacement analysis

This document show the Replacement Analysis of modling machine. Is replacement give profit to company or not?

  Business finance task - capital budgeting

Your company is considering using the payback period for capital-budgeting. Discuss the advantages and disadvantages of this technique.

  Analysis of the investment

In this project, you will focus on one of these: the additional cost resulting from the purchase of an apple press (a piece of equipment required to manufacture apple juice).

  Conduct a what-if analysis

Review the readings and media for this unit, including the Anthony's Orchard case study media. Familiarise yourself with the Anthony's Orchard company and its current situation.

  Determine operational expenditures

Organisations' behaviour is guided by financial data. In the short term, such data will help determine operational expenditures; in the long term, historical data may help generate forecasts aimed at determining strategic plans. In both instances.

  Personal financial management

How much will you have left over each half year if you adopt the latter course of action?

  Sources of finance for expansion into new foreign markets

A quoted company is considering several long-term sources of finance for expansion into new foreign markets.

  Long term financial planning

This assignment is designed for analyze Long term financial planning begins with the sales forecast and the key input in the long term fincial planning.

  Explain the role of fincial manager

This assignment explain the role of fincial manager, function of manger. And what are the motives of financial manager.

Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd