Opting for the lease is a more favorable choice. To illustrate, we examine the calculations for both options. First, we calculate the Net Present Value (NPV) for the Lease Option:
Year n Details CF ($) DF=1/(1.1)^n PV ($)
1 - Lease payment (30,000) 0.9091 (27,273)
2 - Lease payment (30,000) 0.8264 (24,793)
3 - Lease payment (30,000) 0.7513 (22,539)
4 - Lease payment (30,000) 0.6830 (20,490)
The NPV for the lease option equals (95,096).
For the Buy Option, we carry out the following calculations:
Year n Details CF ($) DF=1/(1.1)^n PV
0 Purchase cost (80,000) 1.0000 (80,000)
1 Maintenance costs (10,000) 0.9091 (9,091)
2 Maintenance costs (10,000) 0.8264 (8,264)
3 Maintenance costs (10,000) 0.7513 (7,513)
4 Maintenance costs (10,000) 0.6830 (6,830)
Residual value at end of year 4 20,000 0.6830 13,660
The NPV for the buy option results in (98,038).
To determine the equivalent annual annuity (EAA) for each option:
EAA = (r × NPV) / (1 - (1 + r)^-n)
where r is the discount rate per period and n shows the number of periods.
Calculating:
Lease option EAA = (0.1 × -95,096) / (1 - (1 + 0.1)^-4) = -30,000.
Buy option EAA = (0.1 × 98,038) / (1 - (1 + 0.1)^-4) = -30,928.
Since the lease option manifests a lower EAA of $30,000 compared to the buy option's $30,928, the lease is deemed the superior choice.
Response:
The type of buying situation is: Modified rebuy
Clarification:
A modified rebuy occurs when an individual or company reorders a product or service previously purchased but now seeks to change the supplier, product details (for example, gel seats) or the sales terms.
