Question

1. Anderson plans to acquire an automated assembly line with ten year life at a cost of sh 10 million, delivered and installed. He plans to use the equipment for only five years.He can borrow the required 10 million at a before cost of 10%.The estimated scrap value is sh 50,000 after ten years, but its estimated scrap value after five years is sh 1 million. He can lease the equipment for 5 years at a rental charge of sh 2.75m payable at the beginning of each year. The lessor will maintain the equipment. However if he buys he will bear the cost of maintenance of shs500,000 per year payable at the beginning of the year.The marginal tax rate is 30%

          Analyze whether the company should purchase or lease the asset

PS: please have another expert try it. it had been done earlier ,same exact question but was locked out. .Thanks!

Answer 1

Answer:

Company should lease the asset.

NPVs of both options are as below:

Differential NPV of 'Lease' over 'Buy' is positive.

Workings:

Before Tax interest cost is = 10%

Since to compare both the options we will be using after tax cash flows, we need to use after tax interest rate.

After Tax interest rate = 10% * (1 - 30%) = 7%