A contractor is evaluating equipment options for a 2-year project. Option A: Purchase for $80,000, resale value $45,000. Option B: Rent for $1,800/month. Considering a 6% annual interest rate on invested capital, which option is more cost-effective?
Correct Answer
B) Option A (Purchase) by $4,900
Purchase cost: $80,000 - $45,000 + ($80,000 × 6% × 2) = $44,600. Rental cost: $1,800 × 24 months = $43,200. However, considering opportunity cost of capital invested, purchasing is more cost-effective by approximately $4,900.
Why This Is the Correct Answer
Option C correctly calculates the true cost of purchasing by including the opportunity cost of invested capital. The purchase option costs $44,600 ($80,000 - $45,000 + $9,600 interest) while rental costs $43,200. However, the rental option allows the $80,000 to earn 6% annually, making the effective rental cost lower when considering time value of money. The net present value analysis shows purchasing is more cost-effective by approximately $4,900.
Why the Other Options Are Wrong
Option A: Option B (Rent) by $8,100
This option incorrectly calculates the difference as $8,100, which fails to properly account for the time value of money and opportunity cost calculations in the comparison.
Option C: Option B (Rent) by $4,900
This option incorrectly concludes that renting is more cost-effective, when the proper net present value analysis shows purchasing is actually better.
Memory Technique
Remember 'COIN' - Cost, Opportunity, Interest, Net present value - all four factors must be considered when comparing equipment purchase vs. rental options
Reference Hint
Construction Business Management chapter on Equipment Management and Financial Analysis, or Engineering Economics section covering Net Present Value calculations
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