Company ABC Inc has just sold an asset for $2.3 million for the purpose of self-financing...

Company ABC Inc has just sold an asset for $2.3 million for the purpose of self-financing a capital expansion program that may include purchase of a piece of manufacturing equipment for $1.6 million. The company’s tax rate is 25%, its required rate of return is 11%, the estimated salvage or recovery value of the equipment at the end of 3 years is $450,000. Given the high-tech nature of its industry, the conservative approach is to use a depreciable life of 3 years on a straight line basis. The alternative is to lease the same piece of equipment for $425,000 over the same period. Should ABC lease or buy? Show your work to justify your decision or recommendation.

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Expert Solution

Lease alternative has higher NPV. Hence lease the asset.

	Lease
Year	Cash flows
0
1	-318750
2	-318750
3	-318750

NPV	($778,934.07)

Buy
Year	Initial cost	Tax shield	Salvage	Net cash flows
0	-1,600,000			-1,600,000
1		133333.3		133,333
2		133333.3		133,333
3		133333.3	337500	470,833

			NPV	($1,027,394.28)

WORKINGS

jeff jeffy answered 1 week ago

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