Question

Suppose Proctor​ & Gamble​ (P&G) is considering purchasing

$ 18$18

million in new manufacturing equipment. If it purchases the​ equipment, it will depreciate it for tax purposes on a​ straight-line basis over five​ years, after which the equipment will be worthless. It will also be responsible for maintenance expenses of

$ 1.00$1.00

million per​ year, paid in each of years 1 through 5. It can also lease the equipment under a true tax lease for

​$4.54.5

million per year for the five​ years, in which case the lessor will provide necessary maintenance. Assume​ P&G's tax rate is

30 %30%

and its borrowing cost is

7.0 %7.0%.

a. What is the NPV associated with leasing the equipment versus financing it with the​ lease-equivalent loan?

b. What is the​ break-even lease

ratelong dash—that

​is, what lease amount could​ P&G pay each year and be indifferent between leasing and financing a​ purchase?

Answer 1