Question

Your firm has just sold non-strategic assets to raise cash for capital investment while avoiding the use of debt. The firm may buy a piece of machinery for $140,000 [with a useful or depreciable life of 4 years]. Your pretax cost of capital is 8% [and your tax rate is 20%]. You can lease the machine for $43,500 per year and the estimated salvage/recovery value at the end of four years [based on actual market data] is $20,000. Should you lease or buy? Showing work.

Answer 1

We need to find the PV of the Lease
payments and residual value
Year	Lease Payment	Residual Value	Total Cash flow	PV factor @6.4%	PV of Cash flows
1	43,500		43,500	0.9398	40,881.30
2	43,500		43,500	0.8833	38,423.55
3	43,500		43,500	0.8302	36,113.70
4	43,500	20,000	63,500	0.7802	49,542.70
					164,961.25
PV of All Lease payments	164,961
Purchase cost of Machine	140,000
As the purchase cost of Machine is lower than the PV of all lease payments , the firm should buy the machine.