Blinko Products wants an airplane for use by its corporate staff. The airplane t
ID: 2456168 • Letter: B
Question
Blinko Products wants an airplane for use by its corporate staff. The airplane that the company wishes to acquire, a Zephyr II, can be either purchased or leased from the manufacturer. The company has made the following evaluation of the two alternatives:
Purchase alternative. If the Zephyr II is purchased, then the costs incurred by the company would be as follows:
The plane would be sold after nine years. Based on current resale values, the company would be able to sell it for about one-half of its original cost at the end of the nine-year period.
Lease alternative. If the Zephyr II is leased, then the company would have to make an immediate deposit of $52,000 to cover any damage during use. The lease would run for nine years, at the end of which time the deposit would be refunded. The lease would require an annual rental payment of $140,000 (the first payment is due at the end of Year 1). As part of this lease cost, the manufacturer would provide all servicing and repairs, license the plane, and pay all taxes. At the end of the nine-year period, the plane would revert to the manufacturer, as owner.
Click here to view Exhibit 11B-1 and Exhibit 11B-2, to determine the appropriate discount factor(s) using tables.
Use the total-cost approach to determine the present value of the cash flows associated with purchase alternative. (Outflows should be indicated with a minus sign. Round discount factor(s) to 3 decimal places, intermediate and final answers to the nearest dollar amount.)
Use the total-cost approach to determine the present value of the cash flows associated with lease alternative. (Outflows should be indicated with a minus sign. Round discount factor(s) to 3 decimal places, intermediate and final answers to the nearest dollar amount.)
Blinko Products wants an airplane for use by its corporate staff. The airplane that the company wishes to acquire, a Zephyr II, can be either purchased or leased from the manufacturer. The company has made the following evaluation of the two alternatives:
Explanation / Answer
1a. Present values of Cash flows associated with Purchase alternative:
A. Present value of purchase cost = $ 750,000
B. Present value of operating cash outflows:
Particulars Year 1-7 Yr 8 Yr 9
1. Annual cost of servicing, license & Taxes 8000 8000 8000
2. Repairs 7000 9000 18000
3. Discounting factor @ 16% 4.038 0.305 0.262
Present values of operating cash outflow = (1+2)*3 60,570 5,185 6,812
= 60,570+ 5,185+ 6,182 = 71,937.
C. Present value of Terminal cash inflow i.e Resale value = 375,000*0.262 = - 98,250
Total cash outflow associated with Purchase alternative = A+B-C = 750,000 + 71,937 -98,250
= 723,687.
1b). Present values of cash flows associated with lease alternative:
A. Present value of deposit = $ 52,000
B. Present value of Annual lease rents = $ 140,000 *4.606 [ Discounting annuity factor @ 16%, 9 years]
= $ 644,916.
C. Present value of terminal cash inflows = 52,000 * 0.262 = - $13,624
Total cash out flows associated with lease alternative= 52,000 + 644,916 - 13,624
= $ 683,292.
Conclusion: It is better to go with lease alternative, since the total costs is lesser when compared to buy option total costs.