An industrial firm needs a $40,000 piece of machinery that has a useful life of
ID: 3410100 • Letter: A
Question
An industrial firm needs a $40,000 piece of machinery that has a useful life of 5 years. Knowing that the machine will have to be replaced every 5 years, the firm has the option of leasing a machine for $10,000 per year, or borrowing $40,000 to buy the machine. The 1st National Bank can provide a $40,000 loan at 7.8% compounded annually over 5 years. Over the 5-year life of the machine: is it cheaper to lease, or to borrow the money and buy the machine? Show all work to support your choice: a simple “one or the other” answer, even if it’s correct, will result in zero credit!
Explanation / Answer
To compare the two options, first we would find the amount accumlated on loan with interest on $40,000 after
5 years.
Amount = Principal( 1 +rate/100)^n
7.8% compounded annually over 5 years
rate = 0.078 ; n = 5
So,Amount = 40,000( 1 +0.078 )^5 = $ 58230.94
So, this the amount he would pay to the bank
If he leases the macine for 5yrs , he would pay $10,000 x 5 = $ 50,000
Its better to lease the equipment than to purchase it on loan