A farmer is considering the purchase or lease of a truck. He can buy a new truck or lease a new truck. He believes that each truck will provide the same service but the costs are different. He has provided the following information. Inflation is assumed to be zero. Assume that the lease payment is constant throughout the lease agreement. Assume that the lease payment would be made at the beginning of the year and the lease ends at the end of the 13th year. The lessor will pay repairs and maintenance. Also assume that this farmer could claim the tax deduction due to the lease payment when it is paid. The new tractor has a price of $41,500, a before-tax net return of -$6,200, an investment life of 13 years, and a terminal value of $10,900. If he was to lease the tractor the operating expenses for this tractor will be $3,500. Suppose that the pre-tax rate of return is 11%, the marginal tax rate is 22%, and the IRS allows him to depreciate the tractor over 8 years using the straight-line method. (i) What is the NPV of the purchased tractor?
(ii) What is the annuity equivalent of the purchased tractor?
(iii) What is the NPV if the tractor was leased?
(iv) What is the annuity equivalent if the tractor was leased?
(v) Which tractor should this farmer choose?