Reference no: EM132731875

Problem - The Randolph Teweles Company (RTC) has decided to acquire a new tractor. One alternative is to lease the tractor on a 4-year tax-oriented contract for a lease payment of $16,000 per year, with payments to be made at the beginning of each year. (Note: The tax shelter from the lease payment in Year 0 occurs at Year 0.) The lease would include maintenance. RTC has a marginal federal-plus-state tax rate of 25%.

Alternatively, RTC could purchase the tractor outright for $40,000, financing the purchase by a bank loan for the net purchase price and amortizing the loan over a 4-year period at an interest rate of 8% per year. Under the borrow-to-purchase arrangement, RTC would have to maintain the tractor at a cost of $1,000 per year, payable at year end. The tractor falls into the MACRS 3-year class with depreciation rates for Year 1 through Year 4 equal to 0.3333, 0.4445, 0.1481, and 0.0741. The tractor has a residual value of $10,000, which is the expected market value after 4 years. RTC plans to replace the tractor at the end of Year 4 irrespective of whether it leases or buys.

Required -

a. What is RTC's present value of leasing?

b. What is RTC's present value of owning? Should the truck be leased or purchased?