Prudent Solutions
Case 26
Lease Analysis
Prudent Solutions, Inc.
Assistants to Tony Davis
Executive Summary:
The Data Acquisition System (DAS) is initially estimated to cost $41.25 million if purchased outright. This purchase can be done using currently invested short-term marketable securities. Leasing is also an option with payments estimated at $12.75 million per year. After analyzing each scenario using the discounted cash flow method, the best option is to lease the equipment rather than purchase it. The net present value (NPV) for leasing the DAS is a negative ($28.10 million) and the NPV for the purchasing the DAS is a negative ($28.64 million). Our net advantage for leasing is $0.543 million.
Summary of Facts:
We have developed a new process that makes spent nuclear rods inert rendering them harmless.
R&D is complete and we are now moving to commercial production of the process in house.
As part of the production equipment a sophisticated Data Acquisition System (DAS) is needed to monitor the entire fuel conversion process to ensure the fuel is safe upon completion. The IRR for this project is estimated to be 24% and the project is judged to have low risk. Risk is based on after tax cost of capital of 11% for low risk, 13% for average risk, and 15% for high risk. The data acquisition system will only be utilized for 4 years regardless of whether it is purchased or leased.
Statement of problems:
Each of us in the decision making process have different views on how to acquire the DAS. Therefore, we need to address each of these problems and determine the best approach for acquiring the new data system. First, what discount rate should we use when evaluating the lease-versus-purchase decision? Should we use the firm’s WACC of 13 percent, or the firm’s rate on secured debt that reflects the lowest risk? Second, we need to determine if it will be better to lease or purchase the new system?
Analysis:
Discount Rate
Lease Analysis
Prudent Solutions, Inc.
Assistants to Tony Davis
Executive Summary:
The Data Acquisition System (DAS) is initially estimated to cost $41.25 million if purchased outright. This purchase can be done using currently invested short-term marketable securities. Leasing is also an option with payments estimated at $12.75 million per year. After analyzing each scenario using the discounted cash flow method, the best option is to lease the equipment rather than purchase it. The net present value (NPV) for leasing the DAS is a negative ($28.10 million) and the NPV for the purchasing the DAS is a negative ($28.64 million). Our net advantage for leasing is $0.543 million.
Summary of Facts:
We have developed a new process that makes spent nuclear rods inert rendering them harmless.
R&D is complete and we are now moving to commercial production of the process in house.
As part of the production equipment a sophisticated Data Acquisition System (DAS) is needed to monitor the entire fuel conversion process to ensure the fuel is safe upon completion. The IRR for this project is estimated to be 24% and the project is judged to have low risk. Risk is based on after tax cost of capital of 11% for low risk, 13% for average risk, and 15% for high risk. The data acquisition system will only be utilized for 4 years regardless of whether it is purchased or leased.
Statement of problems:
Each of us in the decision making process have different views on how to acquire the DAS. Therefore, we need to address each of these problems and determine the best approach for acquiring the new data system. First, what discount rate should we use when evaluating the lease-versus-purchase decision? Should we use the firm’s WACC of 13 percent, or the firm’s rate on secured debt that reflects the lowest risk? Second, we need to determine if it will be better to lease or purchase the new system?
Analysis:
Discount Rate