qAn industrial firm needs a 40000 piece of machinery that ha

qAn 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?

Solution

Option I:

Machine varlue = 40000

Life = 5 years

If purchased interest amount total with principal

= 40000(1+0.078)⁵

= 58230.94

Option II:

Leasing

Cost ./ year = 10000

Total cost for 5 years = 50000

Since total cost under lease is cheaper by 8230.94 leasing is better.