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Case 27:2 Rock Creek Golf Club

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by

Armon Gatus

on 22 November 2014

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Transcript of Case 27:2 Rock Creek Golf Club

Company Background
• Public golf course owned by a private corporation
• Manager Lee Jeffries faces a decision regarding the replacement of 40 fully depreciated golf carts
• Proposals were provided by two salespersons, A and B.
• A proposes to buy each cart for 2,240.00 with a salvage value of 200.00 after five years
• B proposes to lease each cart for 500.00 per year

Case Facts
Rock Creek Golf Club is a public golf course owned by a private company and managed by Lee Jeffries. The case entails a debate about the golf carts used to take players around the course instead of walking around. The carts they already owned were old and there was a need for new golf carts.

Approached by two Salesmen, Lee Jeffries was forced to choose to make a deal with one of them. Salesman A offered carts at 2,240.00 each and at the end of five years the expected salvage value was going to be $240 each.
Case Facts
Case 27:2 Rock Creek Golf Club
Group members

Balaoro, Sarah Joy
David, Joanne Paola
Dela Pena, Marlon
Gatus, Armon
Khdial, PreetiKaur
Masagca, Ma. Stephanie
Perez, Gellie
Suy, Lorenzo
Valerio, Darla Kricia
Salesman B proposed to lease the golf carts for 500.00 dollars per cart per year. This was payable at the end of the year for five years and the contract could be canceled at any time with 90 days notice. This deal was easier to get out of.

Either way 420.00 dollars in costs per cart per year were expected and revenue of 84,000.00 per year was expected.

The Director of Rock Creek Golf Club who will provide crucial information to the entire Board of Directors who will ultimately decide regarding the purchase or lease of new golf carts

1. What should the Board of Directors of RCGC do with regard to the replacement of the 40 old golf carts?
Statement of the Problem
• To save costs in the replacement of the old golf carts
• To decide on the best option regarding the replacement of old golf carts

Objectives
• NPV of leasing the golf carts versus NPV of outright purchase
• Interest rates on borrowing funds for purchase and interest rates on leasing
• Salvage value of carts in case of outright purchase

Areas of Consideration
Areas of Consideration

Areas of Consideration
Question #1
Question #2
Sales price per cart (future value) $ 2,240.00
Lease Payment per cart per year (Payment) $ 500.00
Lease Term (n) 5years

Future Value = payment (PV factor of annuity)
$ 2,240.00 = $ 500 (PV factor for annuity)
$ 2,240.00 = PV factor of annuity
_____
$ 500
4.48 = PV factor of annuity

Annuity Table: Present Value of $1 per year for each of t years= 1/r – 1/ [r(1+r)^t]

Question #2
Implicit rate is 4%

Interest on borrowing if to buy a cart 8% Opportunity Cost
Interest of leasing cart 4%
Difference 4%

From the perspective of RCGC creditor, lumpsum payment from RCGC would allow the creditor invest the payment which will earn money, because as time passes, earnings on investment increases. Whereas when carts are to be leased to RCGC, B Company cannot invest today since lease payments are to be received annually. Moreover RCGC shall return the carts at the end of the lease terms. B Company charges only 4% since B Company can use the same golf carts to lease another golf clubs.

Question #3
As indicated by the RCGC director, Jeffries’ payback analysis and comparison of purchase costs versus undiscounted lease payments was too simplistic. A net present value analysis, using a time horizon of five years and a discount rate of, say, 8 percent (some companies roughly estimate their cost of capital as equaling their pretax debt cost) is appropriate.

We have specified accelerated depreciation because, although more complicated for the student than straight-line, RCGC would almost certainly use an accelerated method on its income tax return.
Recommendations and Conclusions
In conclusion of this case, we learned that leasing and purchasing items for the purpose of business has different implications on the financial status of the company. This is especially true when the terms for each are different.

We would recommend that Mr. Jeffries take all the analysis he can consider into account before making his decision keeping in mind that the revenues and expenses he will generate will be the same regardless of whether he leases or buys the carts. I would then pick the option with highest NPV and with the payments for both principal and interest that make sense for his company.

Learning Point
At first glance, to purchase capital assets may appear to be the best option as compared to leasing, but a NPV analysis which would indicate the value of the future cash flows is crucial in making the right decision. But then again, for businessman perspective, Mr. Jeffries should LEASE first and then decide after a year if he can consider purchasing if revenue permits.
Question #4
Differential NPV (After Tax) $ 4,000.00
Divided by PV Factor $ 3.993
Future Value (After Tax) _______
$ 1, 002.00

Future Value (Before Tax) 1002/66% $ 1, 518.00
Divided by No. of Carts 40
Decrease in Annual Lease ________
Payment/cart $37.95

Case 27:2 Rock Creek Golf Club
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