Problem 25-6

Slow to Change Company has decided to computerize its accounting system. The company has two alternativesit can lease a computer under a three-year contract or purchase a computer outright.

If the computer is leased, the lease payment will be $5,000 each year. The first lease payment will be due on the day the lease contract is signed. The other two payments will be due at the end of the first and second years. The lessor will provide all repairs and maintenance.

If the company purchases the computer outright, it will incur the following costs:

Acquisition cost $10,500

Repairs and maintenance:

First year 300

Second year 250

Third year 350

The computer is expected to have only a three-year useful life because of obsolescence and technological advancements. The computer will have no salvage value and be depreciated on a double-declining-balance basis. Slow to Change Company's cost of capital is 16%.

a. Calculate the net present value of out-of-pocket costs for the lease alternative.

b. Calculate the net present value of out-of-pocket costs for the purchase alternative.

c. Do you recommend that the company purchase or lease the machine?