Managerial Economics: A Problem Solving Approach
5th Edition
ISBN: 9781337106665
Author: Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike Shor
Publisher: Cengage Learning
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A client has an existing CAD/CAM system that costs $95,000 per year to lease (payable at the end of each year of use) and a new contract the client is considering entering will fix the price for over the next four years. The client is also considering purchasing a CAD/CAM system to replace its currently leased system (rather than renewing / entering a new lease contract). The new system will cost $450,000 to purchase and install. The system has an estimated life of five years, when it is expected to become obsolete, but it will have a salvage value of $25,000. The interest rate is projected to be 6% per year during the life of the project.
a. Draw a cash flow diagram for the next four years for the existing system (leased system) and a separate cash flow diagram for the system that is being considered for purchase.
b. For each option (leasing and buying), calculate the value of all cash receipts and disbursements at the end of the third year.
c. Compare the value of each option at the end of the third year. What should the client do?
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