Your equipment analysis shows: Purchase price $200,000, annual operating cost $35,000, resale after 5 years $75,000. Rental is $5,500/month. Assuming 10% cost of capital, which option is better for a 5-year project?
Correct Answer
A) Options are approximately equal
Rental: $5,500 × 60 months = $330,000. Purchase: $200,000 + ($35,000 × 5) - $75,000 = $300,000 plus time value of money considerations make them approximately equal.
Why This Is the Correct Answer
The correct answer is D because when comparing purchase vs. rental options, you must consider the time value of money using the given cost of capital. While the simple calculation shows rental at $330,000 and purchase at $300,000 (suggesting a $30,000 difference), applying the 10% discount rate to future cash flows makes the net present values approximately equal. The time value of money calculations effectively eliminate the apparent $30,000 advantage of purchasing.
Why the Other Options Are Wrong
Option B: Purchase saves $105,000
Option A is incorrect because it suggests purchase saves $45,000, but this amount doesn't match either the simple calculation difference ($30,000) or the NPV analysis result (approximately equal).
Option D: Purchase saves $45,000
Option C is incorrect because it suggests purchase saves $105,000, which is far too high and doesn't align with any reasonable calculation method for this scenario.
Memory Technique
Remember 'TVM equalizes' - Time Value of Money calculations often equalize options that appear different in simple arithmetic, especially when cost of capital is 10% or higher.
Reference Hint
Construction project management texts, Chapter on Equipment Economics and Time Value of Money calculations
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