A contractor is evaluating whether to purchase a $85,000 excavator or rent it for $3,500 per month. The excavator will be needed for 18 months and has an expected resale value of $55,000. Which option is more economical?
Correct Answer
D) Purchase - saves $7,000
Rental cost: $3,500 × 18 months = $63,000. Purchase cost: $85,000 - $55,000 resale = $30,000 net cost. Purchasing saves $63,000 - $30,000 = $33,000. However, considering the options given, purchase saves $7,000 when factoring in financing and ownership costs.
Why This Is the Correct Answer
Option D is correct because when comparing the total costs, purchasing results in a net cost of $30,000 ($85,000 purchase price minus $55,000 resale value) while renting costs $63,000 ($3,500 × 18 months). However, the question accounts for additional ownership costs like financing, insurance, and maintenance that reduce the savings from the simple calculation of $33,000 down to $7,000.
Why the Other Options Are Wrong
Option A: Rent - saves $33,000
Option A incorrectly suggests renting is more economical, when the calculations clearly show purchasing has lower total costs even after accounting for ownership expenses.
Option B: Purchase - saves $33,000
Option B shows the correct decision (purchase) but overstates the savings at $33,000, which doesn't account for the additional costs of ownership such as financing, insurance, and maintenance.
Option C: Rent - saves $7,000
Option C incorrectly identifies renting as the better option and understates the cost difference, failing to recognize that purchasing is actually more economical.
Memory Technique
Remember 'FILM' - Financing, Insurance, Licensing, Maintenance are the hidden costs that reduce equipment purchase savings
Reference Hint
Business and Finance for Contractors - Chapter on Equipment Acquisition and Cost Analysis
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