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Question - Strident 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 4.5%. The terms of the lease and of the purchase are as follows: Lease Annual end-of-year lease payments of $22,000 are required over the 5-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 $30,000 at termination of the lease. Purchase The research equipment, costing $100,000, can be financed entirely with a 7.5% loan requiring annual end-of-year payments of $24,716for 5 years.
The Firm in this case will depreciate the equipment under MACRS using a 5-year recovery period.
Year
Depreciation expense ($)
1
20000
2
32000
3
19200
4
11520
5
6
5760
Required -
1. Calculate the present value after tax cash outflows with leasing.
2. Calculate the present value after tax cash outflows with purchasing.
3. Which alternative, lease or purchase, would you recommend? Why?
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