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Lease vs Buy, Present Value, Rate of Return, Annuity

1) A company has an option to purchase equipment or $24,000 but can lease the identical equipment for $5,000 per month for the next 6 years. Its WACC is 7.656% and the equipment has a salvage value if $1000 an the end of 6 years. Which option should the company take?
? Lease
? Buy
? Indifference
? Not enough information to answer; cash flow from equipment is needed

2) Dad wants to buy his son a new car on his 18th birthday. His son just turned 13, and Dad estimates the new car will cost $28,000 at the time of purchase. Rates on 5 year certificates of deposit are currently at 5%, with quarterly compounding. How much does Dad need to deposit today to have $28k at maturity?
Options:

? 10,553
? 21,840
? 25,766
? 27,424

3) An investor deposits %18,000 into a fixed, 5-year CD with annual compounding. At the maturity date, the CD is worth $211,000. What average annual rate was earned on this investment?
Option:
? 3.04%
? 3.23%
? 14.69%
? 17.22%

4) You deposit $1000 dollars today in a fixed rate, tax deferred annuity, which guarantees an 8% return with quarterly compounding. Commencing with the next year, you subsequently deposit $250 every three months at the end of the period, for the next 9 years. What is the value of the annuity at maturity?

Options:
? 10,720
? 12,999
? 15,038
? 15,298

Solution Preview

Note: the abbreviations have the following meanings

FVIF= Future Value Interest Factor
FVIFA= Future Value Interest Factor for an Annuity

They can be read from tables or calculated using the following equations
FVIF( n, r%)= =(1+r%)^n
FVIFA( n, r%)= =[(1+r%)^n -1]/r%

A company has an option to purchase equipment or $24,000 but can lease the identical equipment for $5,000 per month for the next 6 years. Its WACC is 7.656% and the equipment has a salvage value if $1000 an the end of 6 years. Which option should the company take?
? Lease
? Buy
? Indifference
? Not enough information to answer; cash flow from equipment is needed

Answer: ? Buy as Present Value (PV) of buying is cheaper
(See calculations below)

We have to compare the PV of purchase costs with the PV of leasing costs

Purchase

Cash outflow at time 0= $24,000
Salvage value at time 6= $1,000
PV of salvage :

n= 6
r= 7.6560%
PVIF (6 periods, 7.656% rate ) ...

Solution Summary

Answers Multiple Choice Questions on Lease vs Buy, Present Value, Rate of Return, Annuity

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