Calculate the after-tax cash outflows associated with each alternative. Calculate the present value of each cash outflow stream, using the after-tax cost of debt. Which alternative – lease or purchase – would you recommend? Why?
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JLB Corporation is attempting to determine whether to lease or purchase research equipment. The firm is in the 40% tax bracket, and its after-tax cost of debt is currently 8%. The returns of the least and of the 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 costs will be paid by the lessor; insurance and other costs will be borne by the lessee. The lessee will exercise its option to purchase the asset for $5,000 at termination of the lease.Purchase The research equipment, costing $60,000, can be financed entirely with a 14% loan requiring annual end-of-year payments of $25,844 for 3 years. The firm in this case will depreciate the equipment under MACRS using a 3-yar recovery period (33.33%, 44.45%, 14.81%, and 7.41%, respectively). The firm will pay $1,800 per year for a service contract that covers all maintenance costs; insurance and other costs will be borne by the firm. The firm plans to keep the equipment and use it beyond in 3-year recovery period.
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Calculate the after-tax cash outflows associated with each alternative.
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Calculate the present value of each
cash outflow stream, using the after-tax cost of debt. -
Which alternative – lease or purchase – would you recommend? Why?
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