CONTENT

Part 1 Overview
1.1 1.2 2.1 2.2 3.1 3.2
3 3 4 6 6 7

Part 2 Time Preference and Investment Appraisal Methods

Introduction A simple outlook

Part 3 Analysis of Data

3.2.1 3.2.2 3.2.3 3.2.4

Overview of the significance of Time preference Investment Appraisal Methods Incremental Cash flows The Discount Rate

3.3

Risk Tax Rate Inflation Changing short-term interest rates

Part 4 MIRR

NPV and Other Related Calculations

9 9 10 11 11 11 13 14 17 19 25 25 27 29

Part 5 Sensitivity Analysis Part 6 Limitations and Conclusion

6.1 6.2 Limitations of the Analysis Conclusion

References

LIST OF TABLES
Table 1.1: Table 1.2: Table 3.1: Table 3.2: Table 5.1: Table 5.2: Table 5.3: Table 5.4: Table 5.5: Table 5.6: Figure 5.1: Chart 5.1: Table 6.1:
Cash flows generated from buying a TV Incremental cash flows The NPV calculation The 20% variations Sensitivity NPVs

Cash flows generated from renting a TV

Changes in the cash flows with a -20% variation in the residual value Elasticities

The effects of the life-span of 3.2 years on the cash flows Breakeven results IF functions Buy vs. rent NPV profile The one TV case

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Overview
1.1 Introduction

Part 1

To rent or buy is a basic (yet at times difficult) question that each individual faces on numerous occasions throughout their lives. This question is of high importance and we tend to find ourselves comparing the pros and cons of buying as opposed to renting on a regular basis. There are several reasons why a person might choose renting over buying or vice versa. This could be viewed from different perspectives and it is often a subjective matter, which varies from one individual to another.

There appears to be at least one aspect of this decision making process that is common among consumers; this, of course is the financial aspect. When a person has to choose between buying and renting, he tends to choose the option which maximises the benefits, which in financial terms translates into maximising wealth. Wealth as defined by Lumby (1984, p.6) is the purchasing power or to put in more straightforward terms, money or cash. An individual who attempts to get the best deal in order to maximise his wealth has to make an investment decision. An investment decision is defined by Lumby (1984, p.11) as one which involves the firm in making a cash outlay with the aim of receiving, in return, future cash inflows. Of course, these investment decisions are not always for firms and can be applied to simple personal investments as well. The concept regarding an investment decision discussed above will be applied to the advertisement regarding buying a TV and whether it benefits the consumer more than renting one. Whether this advertisement is misleading or not will be discussed by conducting thorough analysis. Initially, this matter will be looked at from the point of view of an individual with no knowledge or background in finance. It is assumed that this individual does not take into account the time value of money, inflation, tax effects and some of the other parameters and will only make a decision based on some basic calculations (where he treats renting and buying separately), and other benefits that he will receive should he decide to purchase the TV. After this basic outlook, more common methods of investment appraisal will be used and more assumptions will be made regarding some of the key variables which are used in making these calculations.

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In this section the advertisement will be analysed from the point of view of a mature and sensible individual who would like to choose between buying a TV and renting it. This individual, however, has no background knowledge of finance and his decisions are based on basic calculations and limited assumptions. For instance, it is a reasonable assumption to make that the average person would not take inflation or interest income into account when making a small financial decision. Of course, more factors are often considered when the investment constitutes a higher percentage of the individuals net disposable income. Because the individual will only be able to take advantage of the 200 part-exchange discount if he buys a second TV after the initial 4 years are up, it is assumed that the lifespan of the TV is 4 years. Hence, the cash flows generated are considered for 8 years. The TV is purchased at the beginning of the first year and rental payments are made at the beginning of each year. It is also reasonable to assume that the residual value of the TV is 200. This makes sense since if the residual value of the TV was any less than 200 the company would have incurred a loss by their offer. As implied in the advert, it will be assumed that the rental charges are 100 per annum. By disregarding inflation, interest, and any other parameters, the cash flows from buying and renting are shown separately (see tables 1.1 and 1.2). 1.2 A Simple Outlook

The cash flow at the beginning of the 8th year is zero. We assume the TV is needed only for 8 years. The buyer sold the second TV at the beginning of the 8th year without purchasing a new one; hence it is assumed there is no need to rent a TV neither.
1

Table 1.1 Cash flows generated from buying a TV

Table 1.2 Cash flows generated from renting a TV

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As can be seen from tables 1.1 and 1.2, the total cash outflow from renting a TV is the same as buying one. From this perspective, it certainly cannot be said that the TV advertisement is misleading, or that the company is conducting an illegal activity. If the Time Value of Money, inflation and other factors are not considered, it would appear that the person would break even by purchasing the TV and taking advantage of the part-exchange discount, as opposed to paying 100 rent annually. Although from a financial perspective he would break even, by purchasing the TV, he has the benefit of ownership.

These calculations may appear too simplistic since they do not take into account the timing of the cash flows; however if the person has savings in a deposit where he does not earn any interest, then time preference may not be a big issue after all.

In the previous section, the advertisement was analysed from the perspective of an individual who treated the decision to rent and buy separately. Now it is appropriate to look at the problem using some investment appraisal methods. One important factor which was not considered in the previous section was the time preference. Dobbs (2000) discussed that individuals would prefer having 1 today as opposed to having 1 a year from now. The reason for this lies behind three important factors: 1. Risk: Future cash flows are uncertain and hence risky

Part 2

06

Time Preference and Investment Appraisal Methods

2.1 Overview of the
significance of time preference

2. Inflation: In most economies inflation is present and prices are assumed to increase over time. (There are, however, some exceptions; for instance, the Japanese economy is currently suffering from deflation). This means that, with an annual inflation rate of f, 1 next year is only worth 1 / (1+f) today.

3. Interest: An individual with 1 today is able to save the money at bank and earn interest. For instance, if the banks interest rate is 5%, this individual will have 1.05 after one year.

Before conducting any analysis to decide whether the TV advertisement is misleading or not, some popular investment appraisal techniques are briefly introduced and their limitations are highlighted. This will be helpful in identifying the appropriate methods which can be used for this analysis.

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2.2 Investment Appraisal Methods Investment appraisal methods are divided into two groups:
Non-Discounting:
Examples: Payback Period (PBP) Return on Capital Employed (ROC)

Discounting:

Examples: Discounting Payback Period Net Present Value (NPV) Internal Rate of Return (IRR)

Generally, the non-discounting appraisal methods such as the PBP and ROC are considered to be simple to use and inexpensive. PBP, for instance, calculates the number of periods it takes for a project to payback the initial investment or, in other words, the first cash outlay. Dobbs (2000) has highlighted that the general idea is that a project that pays back the initial investment faster is a better project. The PBP is simply calculated by adding the money cash flows until the result is positive. The advantage of using the PBP is its simplicity. In other words, it is a good rule of thumb, appropriate for using in small projects. Using other investment appraisal methods for small projects could be expensive and time-consuming. There are, however, two disadvantages in using this method. Firstly the cash flows after the payback period are not taken into account and secondly the time value of money is not considered. ROC is another non-discounting method with a lot of variations in the way it is calculated. In one case, the ROC is simply calculated by averaging the profits throughout the projects life and dividing this by the initial investment. The improvement of this method over the PBP is that it also takes into account the cash flows after the payback period, however once again the time value of money is not considered. To ensure that the time value of money (TVM) has been taken into consideration when conducting the analysis, discounting investment appraisal methods will be used. One of these discounting techniques is the Discounting payback Period (DPBP), which is an

08
improvement over the non-discounting PBP method. It discounts the cash flows and takes into account their timing. However, as with the original PBP method, the cash flows after the payback period are not considered and the accept or reject decision is simply based on how quickly the project paybacks the initial cash outlay. One of the most important investment appraisal methods, regularly used in big corporations and in projects of big scale, is the Net Present Value (NPV). Dobbs (2000) mentioned that the NPV can be interpreted as a tool which shows the immediate cash value of a project. Some other discounting appraisal methods will be discussed in the next section and will be used to analyse the advertisement and make subsequent investment decisions.

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Part 3

Analysis of Data
3.1 Incremental Cash Flows

In this part we initially try to establish the cash flows that will be used for conducting this analysis. The buy or rent situation needs to be treated together and not separately, hence Incremental cash flows will be used. This will merely show the incremental changes in the cash flow when the TV is purchased, as the individual saves money by not paying rental charges any longer. Before demonstrating the cash flows, some assumptions need to be made: The TV which can be rented (purchased) is the 42 LCD Panasonic TV. However it is assumed that each year a newer version of the same TV could be rented. If that is not the case, the rent charges would drop for the same model as newer versions get released in the market and the older versions drop in value. The decisions to buy and rent the TV are mutually exclusive (one either buys the TV or rents it but not both at the same time). No deposit was needed to be paid to the rental company.

The second TV purchased in year 4 is the newer version of the 42 LCD Panasonic TV, which costs 600 in real terms. For simplicity, let us assume that the life-span of the TV is 4 years. This assumption is made because the part-exchange deal is made 4 years after the first TV is bought. As a result, the cash flows are considered for a life span of 8 years.

The 200 part-exchange discount is in nominal (money) terms and equal to the residual value of the first TV in year 42. The discount offer is made today and hence it makes sense that no adjustments have been made to account for the inflation. The rental charge as implied by the advertisement is assumed to be 100 per annum and in real terms.

The reason behind why the residual value of the TV equals the part-exchange discount in nominal terms has already been discussed in section 1.2.
2

Although generally electronic components get cheaper in time due to technological advancements, in this case it is assumed that there is a period of technological stagnation and as a

10
result inflation affects the prices of electronic components3. It is assumed that the TV is purchased at the beginning of the first year and rental payments are made at the beginning of each year (i.e. Annuity Due). It is assumed that the residual value of the TVs both in the 8th and 4th year is the same in real terms.
The importance of this assumption will be discussed in more detail in section 3.2.3.
3

In the subsequent sections, assumptions regarding some important parameters such as inflation and tax will be discussed in more details. Table 3.1 demonstrates the incremental cash flows:

The calculation for converting the 200 nominal discount into real terms is shown in the section 3.2.3 under the title name inflation. For simplicity, assume that the residual value of both TVs in real terms is 184.77 which as discussed before, is the same as the value of the part-exchange discount in nominal terms.
4

Table 3.1 Incremental cash flows

For simplicity, assume that the individual has sufficient funds in his savings to purchase both the first and the second TV. Since this individual does not need to borrow money in order to purchase the TV, it is safe to assume that the discount rate is the 5% savings rate. This means that if the individual keeps the money in his savings he will earn 5% interest per annum. However, to use the correct discount rate for our calculations, it is important to take into account the factors affecting it.

3.2 The Discount Rate

11
3.2.1 Risk Risk is an important factor to consider as it is one of the main reasons for time preference. The idea is that the longer the investment horizon, the more risky and uncertain the future cash flows. Hence individuals usually require a higher rate for longer investments to compensate them for this risk. This is a well-established theory, which in finance is referred to as the Term Structure of the interest rates. For the sake of simplicity, in the NPV calculations, risk is not considered. However, when conducting sensitivity analysis, it will be shown how sensitive the NPV is to changes in the interest rate and whether excluding risk from the NPV calculation had an impact on the overall decision.

3.2.2 Tax Rate

Assume that the tax rate on personal income is 20% and remains at this rate for the 8- year period in consideration. Since this individual receives interest on his savings, it is important to remember that the interest income is taxable and hence the discount rate needs to be adjusted to reflect the appropriate rate. To calculate the net discount rate, the following formula is used.

The personal tax rate on income is 20% and the nominal savings rate is 5%. By substituting these values in the above formula the tax adjusted discount rate is as follows:

3.2.3 Inflation

Let us assume that the inflation rate is stable at a rate of 2% per annum for the foreseeable future. This is not necessarily an unreasonable assumption, since most developed economies often have a target inflation rate. In order for this assumption to be more realistic, it will be assume that this stable rate is the core inflation rate as opposed to the headline inflation. The core inflation simply removes volatile items (such as food and energy prices) from the CPI basket in order to get a more realistic inflation rate. Another assumption was made earlier that the electronics industry, in this case, is not a decreasing cost industry. With the above assumptions it can be concluded that the

12
rental company took inflation into consideration when calculating the rental charges to be received from each customer, without considering the future cost of electronic components (which would affect the TV prices). Thus the fixed cash flow of 100 per annum, is real cash flow. Treating 100 per annum as nominal cash flow is incorrect, since one would expect the nominal (money) cash flow to rise over time due to inflation. When dealing with real cash flows, the discount rate used for calculating the NPV should also be converted to the real discount rate. The banks 5% saving rate does not take inflation into account and is in nominal (money) terms. Therefore it should be converted to the real discount rate. It has already been established that the nominal after-tax discount rate is 4%. To calculate the real after-tax discount rate, the below formula is used:

Since all calculations will be made in real terms, the 200 nominal part-exchange discount also needs to be adjusted for inflation. To convert the 200 nominal discount, which is expected to be received 4 years from today, into real terms, the below formula is used:

13
3.2.4 Changing Short-term Interest Rates In this report it will be assumed that the short-term interest rates will not change throughout the 8-year period and will remain at a nominal (money) rate of 5%. However, if the money is saved in an account which is subject to floating interest rates, then the rates will change. This is merely an assumption. The NPV is calculated by the formula below:

However, when interest rates change with time, using forward rates to calculate the NPV gives more accurate results. In this case, assuming that the one-period forward interest rates are r_1,r_2,,r_Nthe NPV can be calculated more accurately by using the below formula:

When conducting the analysis, it will be assumed that the 5% nominal discount rate will not change throughout the 8 years. Many assumptions were made regarding the discount rate in this section. Some of these assumptions may be somewhat unrealistic, which could affect the appropriate discount rate that should be used in the calculations. In part 5, the sensitivity analysis will indicate how sensitive the results are to a change in the discount rate, and whether unrealistic assumptions could have a material effect on the buy vs. rent decision.

14
In the previous section, the appropriate discount rate and incremental cash flows to be used in the NPV calculation have been established. This information is used to calculate the NPV of the incremental cash flows. 3.3 NPV and Other Related Calculations
Table 3.2 The NPV calculation

The accept or reject decision rule for NPV is as follow: - Accept the project if NPV>0 - Reject the project if NPV<0

In this case the NPV is -77.83, which indicates that the individual is worse off by buying the TV. An NPV of -77.83 simply states that by taking up the deal, the individual loses 77.83. Note that in our previous analysis in which we did not consider tax, inflation and the time value of money, our results were marginal and indicated that from a financial perspective the individual is indifferent between purchasing a TV and renting one. However, it can now be seen that when these factors are taken into consideration, the individual actu-

15
ally incurs a loss by purchasing the TV. Some other investment appraisal methods can be used to support these findings. For instance, the Net Benefit Cost Ratio is defined as net present value divided by the present value of the initial investment.

The way this can be interpreted is that for each 1 of the initial investment, NPV of -0.16 has been generated. The accept or reject decision rule for NBCR is as follow: - Accept the project if NBCR>0 - Reject the project if NBCR<0

From a financial point of view, this indicates that the individual will incur a loss should he take up the deal. NBCR is mainly useful when there is a budget constraint on the decision-maker and there are many projects to be considered. If that is the case, the projects that are chosen in the order of their NBCR, in total, will generate more NPV. Benefit Cost Ratio is closely related to the Net Benefit Cost Ratio.

The accept or reject decision rule for BCR is as follows: - Accept the project if BCR>1 - Reject the project if BCR<1

16
This once again supports our previous findings. Terminal Net worth (TNW) is another investment appraisal method. Where NPV values the projects cash flows at time t=0, TNW values the cash flows at the end of the projects life by compounding the cash flows as opposed to discounting them.

Since , Dobbs (2000) noted that the TNW is positive (negative) whenever NPV is positive (negative). Thus the TNW value of -90.9 supports the reject decision.

All the above findings indicate that from a financial perspective it is better to rent rather than buy a TV. However, there are limitations to this analysis and many assumptions need to be made. Although tax, inflation and TVM have been taken into account when conducting these analyses, risk and uncertainty of future cash flows, the lifespan of the TV and many other important factors have not been considered. These will all be analysed in detail later in this report.

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Part 4
MIRR

In this part we initially try to establish the cash flows that will be used for conducting this analysis. The buy or rent situation needs to be treated together and not separately, hence Incremental cash flows will be used. This will merely show the incremental changes in the cash flow when the TV is purchased, as the individual saves money by not paying rental charges any longer. Before demonstrating the cash flows, some assumptions need to be made:

The saving and the borrowing discount rate are the same in this case, which is the adjusted 1.96% savings rate derived beforehand.

The accept or reject decision rule for MIRR is as follows: - - Accept the project if MIRR>Discount Rate Used Reject the project if MIRR<Discount Rate Used

18
Since 0.65% is less than the 2.35% savings rate, the individual will benefit by renting as opposed to buying the TV. This also indicates that if the interest rates fall as low as 0.65%, then the cash flows will be marginal (NPV=0) and only then it is worth considering purchasing the TV.

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Part 5
Sensitivity Analysis

By conducting sensitivity analysis it will be shown how changes in the parameters used in the NPV calculation affect the decision of whether to rent or buy. This is of high importance as it will show, whether, for instance changing the inflation rate by a margin of +/- X% has any effect on the buy versus rent decision. There are, however, limitations to this analysis: It will not be known with certainty how much each variable will change in the future. Due to the current economic situation of many countries, these variables could have extreme values, and thus this sensitivity calculation could be of limited accuracy.

The different methods of sensitivity analysis that will be conducted are:

1
+/- 20% change in each variable:
The respective parameters will be changed by +/-20% of their original value.

Another important issue is with the way the sensitivity analysis will be conducted. In this analysis only one parameter will be changed, whilst the rest of the parameters remain at their original value. Realistically speaking all the parameters could change and each could get different values.

Breakeven Results:
It will be shown how much change in each variable will result in an NPV of Zero.

The following parameters will be changed: 1. The Price of the TV (Both TVs) 2. Inflation Rate 3. Nominal Interest Rate 4. Tax Rate 5. The Residual Value of the TV 6. Rental Charge

+/- 20% change in each variable:

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The table below shows the 20% change in the above variables and their effects on the NPV. Please note that the 200 part-exchange discount will not be included in the analysis as this amount is fixed.
Table 5.1 The 20% variations

Table 5.2 Sensitivity NPVs

There are two important points which need to be mentioned with regards to the above calculations. 1

As shown in table 5.3, with a variation of -20% in the TVs Residual Value, the cash inflow in year 4 would be 184.77, and 147.82 in year 8. If the TVs residual value is 147.82 (real terms) in both years, the cash inflow on year 8 would be 147.82 as this is the price the individual can sell this TV for. However, in year 4, the individual would prefer to use the discount as opposed to selling the TV at a lower price and benefit by using the part-exchange discount.

Both the part-exchange discount and the residual value of the TV are in real terms.
5

For simplifying the NPV calculations, the 20% variations of these two numbers were rounded to the closest whole numbers of 3 and 5.
6

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Table 5.3 Changes in the cash flows with a -20% variation in the residual value

With a variation of +20% on the other hand, the cash inflows in both years will be 221.72. (The individual would prefer to sell the TV instead of using the part-exchange discount) By referring to Table 5.4, it can be seen that the variation of -20% in the TVs life-span is roughly 3 years, which means at the beginning of the 3rd year, he has to pay rent for a TV (he will not buy a new TV as he wants to use the discount in the 4th year). Assuming the life-span of the second TV is also 3 years, in this case he will sell the TV in year 7. This is because he is no longer waiting to use an offer and he will benefit by selling the TV straight-away for its parts. The 184.777 in year 8 is in real terms. Since the TV in this case is sold in the 7th year, its residual value for this year should be calculated in real terms by using the below formula:

One of the assumptions was that the real price of both TVs is equal in years 4 and 8.
7

Table 5.4 The effect of the life-span of 3.2 years on the cash flows

22
Variation of +20% on the other hand is about 5 years. This results in a higher residual value in both years 4 and 8 (we assumed the TV is needed only for 8 years). An estimate of the value of the TV with in this case is:
Please note that this is only a rough estimation. Realistically speaking this formula will allow the TV to has a residual value higher than the price it was purchased. Therefore an upper limit of 300 in money terms (277.15 in real terms) has been incorporated into the excel function so that the valuation is more realistic.
8

To calculate the elasticities the below formula is used:

Table 5.5 Elasticities

The table below indicates the percentage change in each parameter which results in an NPV value of zero.

2 Break even values and associated elasticities:

Table 5.6 Breakeven results

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Figure 5.1 IF functions

The above calculations were made using the Solver function in Excel. Conducting this analysis for two of the parameters9 required the use of complex if functions. The picture below is a snap-shot of the excel sheet used, and an example of the functions which were written for undertaking the above analysis.

A CD is attached to this report containing the excel spread-sheet used for making these calculations. All explanations of the functions used are inserted in the cells in the form of a comment as shown in the picture 5.1. From the analysis above and as indicated by the elasticities in the tables 5.5 and 5.6, it can be seen that changes in the TVs price and the rental charges have the most effect on the rent or buy decision. Also by looking at the table 5.2 and analysing the NPV values, it can be seen that a 20% variation in the TVs lifespan, rental charges and the price of the TV can affect the individuals decision from a financial point of view.
As mentioned before, the residual value and the life span of the TV required careful calculations. Changing the lifespan for instance, would have affected the timing and amount of cash flows. To be able to use the solver function, some complex functions had to be written to incorporate these parameters in the calculations.
9

The main parameter that needs to be discussed is the rental charge. The reason for this is that the advertisement implied that an individual who pays 100 or more for rental charges should buy a TV, and it was also implied that at 100 the individual breaks even. However, as it can be seen from the rental breakeven, the individual would only breakeven if he pays a rental charge of 110.40 or more. In a way, it can be said that taking into account the time value of money the

24
advertisement is misleading and the individual would be better off by renting. Another important point which needs to be discussed is with regards to the factors affecting the discount rate. As mentioned earlier, some of the assumptions made with respect to these factors may have not been realistic. Risk was not incorporated into the discount rate and it was assumed that tax, interest rates and inflation are at the same rate. The sensitivity analysis shows that changes in these parameters may not have a material effect on the individuals decision. However, it is important to note that, for instance, the inflation might change at a rate much higher than +/-20%.

Chart 5.1 Buy vs. rent NPV profile

By referring to the chart 5.1, it can be seen that the NPV is marginal when the discount rate is negative and about -1%. In a country suffering from hyperinflation, the inflation rate would increase with a high percentage, which could result in a negative real discount rate, and thus the outcome is a marginal NPV.

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Limitations and Conclusion

Part 6

6.1 Limitations of the Analysis

There are many issues with the analysis conducted in the previous sections. The calculations were correct with the assumption that many of the parameters would remain at the rates forecasted today. The future, almost without exception, is uncertain and so any investment technique can give only investment advice on these forecasts and not a definitive decision. Such techniques can never replace managerial judgement, but they can help to make that judgement more sound (Lumby, 1988, p.23). In reality, these parameters may change dramatically from year to year due to economical, political, technological and societal influences. The governments fiscal and monetary policy could result in a change of the tax rates and interest rates, which in turn would affect the inflation rate. Whenever a parameter was altered in the above calculations, the rest remained unchanged (with the exception of the TVs Life-span). This is a very unrealistic assumption, as some of these parameters are interlinked with one another, and change in one parameter would affect the others. For instance, in an economy with high interest rates, the government would execute an expansionary monetary policy by conducting open market operations and buying government securities, which in turn increases the available reserves in banks, lowers the interest rates and increases the inflation rate. Some other parameters, such as the life-span of the TV or its residual value were rough estimates, which could be of limited accuracy.

In the analysis above, it was assumed that the lifespan of the TV is 4 years and the calculations were made based on this assumption. However, after some investigation it was found that the general consensus is that the Panasonic Plasma TV (claimed to be equivalent to LCD) has a life span of 60,000 100,000 hours. Assuming a 3 hours use per day, this means the TV lasts anywhere between 54 to 91 years. According to Robert Wiley, a reviewer on a TV buying guide website: The specification is somewhat suspect since the process of determining longevity of the product is based on deductive mathematical calculation of phosphor dissipation, and does not take into account the electronic components and the myriad of problems that can occur. Realistically speaking, the life span of

26
the TV could be thought to be anywhere between 8-10 years, which is more than the 4 years assumption in the above analysis. With such a life-span, an individual might decide that the second TV is not needed after all. In this case, keeping all other factors unchanged, the incremental cash flows will be as shown in the table below:
Table 6.1 The one TV case

Calculating the NPV in this case gives a value of 294.31, which indicates that if the rental charges remain at this price, for a TV with a life-span of 8 years, the individual will benefit by purchasing the TV. Note that if this is the case, cash inflow in year 8 is 170.70 because it was assumed the residual value of the first TV in nominal terms was 200. The calculation is shown below:

Another issue which needs to be discussed concerns the offer made by the TV company. In current economical conditions, there is a good chance that the TV companys offer would not be valid after 4 years. In England, for instance, many big companies have gone into administration in the past few years. Woolworths, Clinton Cards, Jessops, HMV, and Blockbuster are only a few to name. If the same happens to the TV company, then there is a high probability that the part-exchange discount offer is of no value.

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Earlier, an assumption was made that there is a period of technological stagnation, where the electronics industry in that period is no longer a decreasing cost industry. This assumption helped the analysis by assuming that even though each year a new version of the TV could be rented, because the technology does not change much, the price of the TVs does not fluctuate that rapidly. This, however, is somewhat an unrealistic assumption. Engineers and scientists are attempting to decrease the cost of the components which are the building blocks of the electronic equipment. This allows for more complex and advanced instruments to be built. Thus it is more reasonable to assume that the rent and TV prices, at least for the same type of technology, would decrease as the time goes by. Another important assumption was that the rental company did not require any deposit. This is an unrealistic assumption as today most rental companies request a deposit. Paying a deposit at the beginning of each year means that money can no longer be saved in an interest bearing account. Also, any minor damage to the TV means that a percentage of that deposit is lost each year. 6.2 Conclusion

The simple analysis at the beginning of the report indicated that it cannot be stated that the advertisement was in any way misleading. If one does not take into account time preference, it will appear that the companys advertisement was genuine. After conducting a thorough analysis, however, it was shown that from a financial perspective the individual is better off by renting. This analysis had limitations and a lot of the assumptions were made based on personal judgement. Considering that by purchasing the TV the individual lost only about 77, this still may be an attractive offer. Roughly the same amount probably had to be paid each year for the security deposit. The sensitivity analysis further indicated that with time preference in mind, the individual should pay a rental charge of 110.14 or more to breakeven as opposed to the 100 mentioned in the advertisement. It

28
also showed that the changes in factors affecting the discount rate do not change the buy or rent decision; however as discussed there are limitations to this as, for instance, the inflation could increase by a percentage much more than 20%, which would affect the buyers decision. As shown in the table 6.1, if the individual buys only one TV with a life-span of 8 years without using the part-exchange discount, he benefits by purchasing instead of renting. However, the point of the analysis was to understand whether the TV companys part-exchange discount offer is attractive, should this individual decide to change his TV in year 4. All the above analysis concludes that it is better to rent the TV; however, this analysis is somewhat simplistic and more complex financial modelling is required.

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Bibliography Brealey, R. A., Myers, S. C., & Allen, F. (2008). Principles of Corporate Finance (9th ed.). New York: McGraw-Hill. CFA Institute. (2012). Economics. New York: Pearson. Dobbs, I. M. (2000). Managerial Economics. Oxford, New York: Oxford University Press.

Lumby, S. (1984). Investment Appraisal (2nd ed.). Wokingham: Van Nostand Reinhold (UK) Co. Ltd. Lumby, S. (1988). Investment Appraisal and Financing Decisions (3rd ed.). Wokingham: Van Nostrand Reinhold (International) Co. Ltd.

Ross, S. A., Westerfield, R. W., & Jaffe, J. (1996). Corporate Finance (4th ed.). Chicago: Irwin. Wiley, R. (n.d.). How Long Do Plasma and LCD TVs Last? Retrieved 01 14, 2013, from Plasma TV Buying Guide: http://plasmatvbuyingguide.com/plasmatv/plasmatv-lifespan.html