Question

With favorable growth prospect, Bien Company requires to add new machinery. The machine would cost $500,000 if purchased; It would be depreciated straight-line to zero salvage over 5 years. Alternatively, it may be leased for $110,000/yr. The firm’s borrowing cost of is 7%, and its tax rate is 40%

1. List the leasing cash flows for year 0 and year 1 – 5.

2. What is the net advantage to leasing (NAL)?

3. What decision should be made regarding lease or buy?

Answer 1

The question is confusing on the starting of the Lease payments; Since the life of the project is 5 years, ideally, the lease payments also should be considered for that particular period; However, since it is mentioned that the leasing cashflows to be cosnidered fro Year 0 and Year 1-5, pls find below worrking:

Based on this assumption, since the NAL is negative, it is appropriate to choose BUY option:

Assuming if the Lease Payouts are only for Year 1 to Year 5 (and paid during respective years only), then the workings are as below;

Based on this assumption, the NAL is positive and it is appropriate to consider the LEASE option;