DCF

[archived_user]

A currently has a warehouse lease that calls for five annual payments of $120,000. The warehouse
owner, who needs cash, is offering A a deal wherein A will pay $200,000 this year and then pay only $80,000
each of the remaining 4 years. (Assume that all lease payments are made at the beginning of the year.) Should A
accept the offer if its required rate of return is 9%, and why?

 

[archived_user]

What’s the PV of each?
A should choose the one with the lower PV.

 

[archived_user]

You can just put the numbers into CF on your calculator and calculate the NPV for each scenario.

 

[archived_user]

Alternately, you could calculate the NPV of switching (i.e. using the incremental cash flows of switching): CF0=120-200=(80); C01=40, etc…
If the NPV is positive, make the change.
NOTE: The NPV based on the incremental cash flows from making the change) will equal the difference in the NPVs of the two alternatives. It’s just a smaller number of calculations.