Reference no: EM13906779
A firm wishes to acquire a new photocopier, but has to decide whether it should purchase the item outright or lease one from a leasing company. It intends to keep the photocopier for 3 years and employs a 12% discount rate in all of its investment projects. The relevant expenditures for the alternative acquisition schemes are given below.
A. Purchase of photocopier:
Purchase price = £5000.
Service contract for maintenance, service, repair, etc. (payable at the start of years 1 and 2) = £200.
Resale value of the photocopier after 3 years = £3500.
B. Leasing scheme
Annual lease (payable at the start of each year for a minimum of 3 payments) = £1000. Maintenance costs and resale value = 0.
(a) Which of the two schemes should the firm choose?
(b) Suppose that because of the cash flow situation the £5000 for the purchase of the photocopier would have to be borrowed from the bank at an interest rate of 12%, and repaid in equal annual instalments at the end of each of the 3 years. What difference does this make to the choice of schemes?
(c) If the borrowing rate demanded by the bank is increased to 18% and the repayment method is as in (b), what difference does this make to the choice of scheme?
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