Question

Lease versus buy

Morris-Meyer Mining Company must install $1.7 million of new machinery in its Nevada mine. It can obtain a bank loan for 100% of the required amount. Alternatively, a Nevada investment banking from that represents a group of investors believes that it can arrange for a lease financing plan. Assume that the following facts apply:

The equipment falls in the MACRS 3-year class. The applicable MACRS rates are 33%, 45%, 15%, and 7%.

Estimated maintenance expenses are $60,000 per year.

Morris-Meyer's federal-plus-state tax rate is 45%.

If the money is borrowed, the bank loan will be at a rate of 12%, amortized in 4 equal installments to be paid at the end of each year.

The tentative lease terms call for end-of-year payments of $350,000 per year for 4 year.

Under the proposed lease terms, the lessee must pay for insurance, property taxes, and maintenance.

The equipment has an estimated salvage value of $350,000, which is the expected market value after 4 years, at which time Morris-Meyer plans to replace the equipment regardless of whether the firm leases or purchases it. The best estimate for the salvage value is $350,000, but it may be much higher or lower under certain circumstances.

To assist management in marking the proper lease-versus-buy decision, you are asked to answer the following questions.

Assuming that the lease can be arranged, should Morris-Meyer lease or borrow and buy the equipment? Explain. Round your answer to the whole number.

Net advantage to leasing (NAL) is $ .

Answer 1