You are the financial advisor to Mr. Agirich who has been having his 400 acres custom

harvested at a cost of $22.00 per acre. However, he has been informed that the price is

going up to $27.00 next year. Moreover, he is considering the acquisition of his own

machine, either through leasing or cash purchase.

If he shifts from custom harvesting to operating the machine himself, he will need to hire

one extra man for 14 days each year at $75.00 per day. Moreover, he estimates that

operating costs, including fuel, lubrication, repair, insurance, etc. will be $8.00 per acre.

The cost of machine purchase is $50,000. The economic life of the machine is projected to

be seven years, with no salvage value. He plans to borrow 80% of the purchase price (20%

down payment) using a loan that is fully amortized at 10% over three years (annual

payments).

He can also obtain control of this machine through a financial lease for $9,600 per year for 7

years, due at the beginning of each year. He will assume responsibility for repair, insurance,

and operation under this financial lease just as though he purchased the machine. Assume

that the tax deduction due to the lease can be taken at the beginning of the year.

He projects his tax rate on marginal income to be 15%. He uses 5-year straight-line

depreciation on the farm machinery he owns. He has other investment opportunities that

promise to pay 10%. Assume that the inflation rate is 0%.

PROBLEM

A.

Assuming all three methods of control (custom hire, leasing, or purchase) are

otherwise satisfactory to him, which would be the best investment?

[Annuity Equivalent(Custom Hire)=$-9,180; Annuity Equivalent(Purchase=$-12,226)

Annuity Equivalent(Lease)=$-12,466]