Question

Lease versus Buy

Big Sky Mining Company must install $1.5 million of new machinery in its Nevada mine. It can obtain a bank loan for 100% of the purchase price, or it can lease the machinery. Assume that the following facts apply:

1. The machinery falls into the MACRS 3-year class. (The depreciation rates for Year 1 through Year 4 are equal to 0.3333, 0.4445, 0.1481, and 0.0741.)
2. Under either the lease or the purchase, Big Sky must pay for insurance, property taxes, and maintenance.
3. The firm's tax rate is 25%.
4. The loan would have an interest rate of 13%. It would be nonamortizing, with only interest paid at the end of each year for four years and the principal repaid at Year 4.
5. The lease terms call for $410,000 payments at the end of each of the next 4 years.
6. Big Sky Mining has no use for the machine beyond the expiration of the lease, and the machine has an estimated residual value of $200,000 at the end of the 4th year.

1. What is the cost of owning? Enter your answer as a positive value. Do not round intermediate calculations. Write out your answer completely. For example, 5 million should be entered as 5,000,000. Round your answer to the nearest dollar.

   $______  

2. What is the cost of leasing? Enter your answer as a positive value. Do not round intermediate calculations. Write out your answer completely. For example, 5 million should be entered as 5,000,000. Round your answer to the nearest dollar.

   $_____  

3. What is the NAL of the lease? Do not round intermediate calculations. Write out your answer completely. For example, 5 million should be entered as 5,000,000. Round your answer to the nearest dollar.

   $______  

Answer 1

a) Cost of owning = $1,083,169

b) Cost of leasing= $980,033

c) NAL = $103,136

Working: