Question

Lease versus purchase   JLB Corporation is attempting to determine whether to lease or purchase research equipment. The firm is in the 26​% tax​ bracket, and its​ after-tax cost of debt is currently

9​%. The terms of the lease and of the purchase are as​ follows:

Lease  Annual​ end-of-year lease payments of $30,000 are required over the​ 3-year life of the lease. All maintenance costs will be paid by the​ lessor; insurance and other costs will be borne by the lessee. The lessee will exercise its option to purchase the asset for

​$6,000 at termination of the lease. Ignore any future tax benefit associated with the purchase of the equipment at the end of year 3 under the lease option.

Purchase  The research​ equipment, costing $70,000​, can be financed entirely with a

14​% loan requiring annual​ end-of-year payments of $30,151 for 3 years. The firm in this case will depreciate the equipment under MACRS using a​ 3-year recovery period. ​

Rounded Depreciation Percentages by Recovery Year Using MACRS for First Four Property Classes
	Percentage by recovery yeara
Recovery year	3 years	5 years	7 years	10 years
1	​33%	​20%	​14%	​10%
2	​45%	​32%	​25%	​18%
3	​15%	​19%	​18%	​14%
4	​7%	​12%	​12%	​12%
5		​12%	​9%	​9%
6		​5%	​9%	​8%
7			​9%	​7%
8			​4%	​6%
9				​6%
10				​6%
11				​4%
Totals	​100%	​100%	​100%	​100%
aThese percentages have been rounded to the nearest whole percent to simplify calculations while retaining realism. To calculate the actual depreciation for tax​ purposes, be sure to apply the actual unrounded percentages or directly apply​ double-declining balance depreciation using the​ half-year convention.

the applicable depreciation​ percentages.)

The firm will pay $1,600 per year for a service contract that covers all maintenance​ costs; insurance and other costs will be borne by the firm. The firm plans to keep the equipment and use it beyond its​ 3-year recovery period.  

a.

The​ after-tax cash outflow associated with the lease in year 1 is ….

​(Round to the nearest​ dollar.)

The​ after-tax cash outflow associated with the lease in year 2 is….

​(Round to the nearest​ dollar.)

The​ after-tax cash outflow associated with the lease in year 3 is ….

​ (Round to the nearest​ dollar.)

The​ after-tax cash outflow associated with the purchase in year 1 is ….

​ (Round to the nearest​ dollar.)

The​ after-tax cash outflow associated with the purchase in year 2 is ….

​ (Round to the nearest​ dollar.)

The​ after-tax cash outflow associated with the purchase in year 3 is ….

​(Round to the nearest​ dollar.)

b.  The total present value of the​ after-tax cash outflows associated with the lease is ….

​ (Round to the nearest​ dollar.)

The total present value of the​ after-tax cash outflows associated with the purchase is ….

​(Round to the nearest​ dollar.)

c.   Which alternative would you​ recommend?

Answer 1

a)

in case of lease:

after tax cash flows year 1 = 30000(1 - 0.26) = $22,200

year 2 = 30,000(1 - 0.26) = $22200

Year 3 = 30,000(1-0.26) + 6000 = $28,200

in case of purchase:

loan amortisation schedule:

after tax cash flow with purchase Year 1 = $22721

Year 2 = $21438

Year 3 = $27677

b)

present value of lease:

so present value of lease = $60,828

Present value of purchase:

present value of purchase = $60,261

c)

since PV of buying option is low Purchasing is recommended