Lim Coaches needs to acquire a new coach. They have the option of leasing the new coach or buying it outright.

The lease proposal involves:

        ·  A five year lease

        · Payments of $100,000 at the beginning of each year

        · A final residual payment at the end of the 5^th year of $500,000

        · No residual value for depreciation calculations

        ·  A possible resale value, if sold after 5 years, of $200,000

If the company chooses to buy the coach, it involves:

        ·   An initial cost of $800,000

        ·   Depreciation, on a straight line basis over 5 years

        ·   No residual for depreciation calculations

        ·   A possible resale value after 5 years of $200,000

        ·  The cost of the coach will be finance with a deposit of 20% by the company and the balance financed with an interest only loan at 10%

        ·  Interest is payable at the end of each year

        ·  The loan principal is repaid at the end of 5 years

Other information relevant to the decision:

        · Company tax of 30% is payable at the end of each year

        ·  Cost of capital is 10% per annum

        · The coach will be sold at the end of 5 years, regardless of which option is chosen

Required:

Calculate the NPV of the lease proposal?

Calculate the NPV of the purchase proposal?

Recommend, based on the NPV, which option should be chosen?