(i) What implicit assumption is made when managers use the equivalent annual benefit method to decide between two projects with different lives that use the same resource?
(ii) You own a cab company and are evaluating two options to replace your fleet. Either you can take out a five-year lease on the replacement cabs for $491 per month per cab, or you can purchase the cabs outright for $31,000, in which case the cabs will last eight years. You must return the cabs to the leasing company at the end of the lease. The leasing company is responsible for all maintenance costs, but if you purchase the cabs, you will buy a maintenance contract that will cost $101 per month for the life of each cab. Each cab will generate revenues of $1076 per month. Assume the cost of capital is fixed at 11.1%.
a. Calculate the NPV per cab of both possibilities: purchasing the cabs or leasing them.
b. Calculate the equivalent monthly benefit of both opportunities.
c. If you are leasing a cab, you have the opportunity to buy the used cab after five years. Assume that in five years a five-year-old cab will cost either $10,300 or $15,800 with equal likelihood, will have maintenance costs of $505 per month, and will last three more years. Which option should you take?