Suppose you are contemplating the purchase of a commercial lawn mower at a cost of $10,000. The expected lifetime of the machine is three years. You can lease the asset to a local business for $4,000 annually (payable at the end of each year) for three years. The lessee is responsible for the upkeep and maintenance of the machine during the three-year period.

If you can borrow (and lend) money at an interest rate of 8 percent, will the investment be a profitable undertaking?
Yes
No

Is the project profitable at an interest rate of 12 percent? Provide calculations in support of your answer.
Yes
No

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hoangkhangpham94 hoangkhangpham94 · Answer 1 · 2019-12-03T11:47:10+01:00

Answer:

At the interest rate of 8%, The answer is Yes. The investment is profitable.

At the interest rate of, the answer is No. The investment is not profitable

Explanation:

For the investment to be profitable, its NPV discounted at the interest rate should be greater than the initial cost of investment of $10,000.

For scenario 1, the interest rate is 8%, the NPV is:

NPV = (4,000/0.08) x ( 1- 1.08^-3) = $10,308.4; which is greater than $10,000. Thus, the investment is profitable

For scenario 2, the interest rate is 12%, the NPV is:

NPV = (4,000/0.12) x ( 1 - 1.12^-3) = 9,607.3; which is lower than $10,000. Thus, the investment is unprofitable.