17-4 Lease versus purchase JLB Corporation is attempting to determine weather to lease or purchase research equipment. The firm is in the 40% tax bracket, and it�s after- tax cost of debt is currently 8%. The terms in the leases and or purchase are as follows.
LEASE-Annual end of year lease payments of $25,200 are required over the 3-year life of the lease. All maintenance cost will be borne by the lease. The lessee will exercise it�s option to purchase the asset for $5,000 at termination of the lease.
PURCHASE-The research equipment, coasting $60,000, can be financed entirely with a 14% loan requiring end-of-year payments of $25,844 for three years. The firm in this case will depreciate the equipment under MACRS using a 3-year recovery period. ( See table 4.2 on page 120 for applicable depreciation percentages) The firm will pay $1,800 per year for the service contract that covers all maintenance cost; insurance and other costs will be borne by the firm. The Firm planes to keep the equipment and use it beyond its 3-year recovery period.
a) Calculate the after tax cash outflows associated with each alternative.
b) Calculate the present value of each cash outflow stream, using the after tax cost of debt.
c) Which alternative�lease or purchase�would you recommend? Why?
Table 4.2---------Percentage by recovery year
Recovery year 3 years 5 years 7 years 10 years