Northwest Lumber Company needs to expand its facilities. To do so, the firm must acquire a machine costing $80,000. The machine can be leased or purchased. The firm is in the 21% tax bracket, and its after-tax cost of debt is 9%. The terms of the lease and purchase plans are as follows: Lease: The leasing arrangement requires beginning-of-year payments of $19,800 over 5 years. All maintenance costs will be paid by the lessor. The lessee will exercise its option to purchase the asset for $24,000 at termination of the lease. Ignore any future tax benefit associated with the purchase of the equipment at the end of year 5 under the lease option. Purchase: If the firm purchases the machine, its cost of $80,000 will be financed with a 14% loan amortised over 5-year period. The machine will be depreciated under MACRS using a 5-year recovery period. The firm will pay $2,000 per year at the beginning of the year for a service contract that covers all maintenance costs. The firm plans to keep the equipment and use it beyond its 5-year recovery period. Determine the after-tax cash outflows of Northwest Lumber under each alternative. Find the present value of each after-tax cash outflow stream, using the after-tax cost of debt Which alternative-lease or purchase-would you recommend? Note: Round all the figures to the neares dollar.
Northwest Lumber Company needs to expand its facilities. To do so, the firm must acquire a machine costing $80,000. The machine can be leased or purchased. The firm is in the 21% tax bracket, and its after-tax cost of debt is 9%. The terms of the lease and purchase plans are as follows:
Lease: The leasing arrangement requires beginning-of-year payments of $19,800 over 5 years. All maintenance costs will be paid by the lessor. The lessee will exercise its option to purchase the asset for $24,000 at termination of the lease. Ignore any future tax benefit associated with the purchase of the equipment at the end of year 5 under the lease option.
Purchase: If the firm purchases the machine, its cost of $80,000 will be financed with a 14% loan amortised over 5-year period. The machine will be
- Determine the after-tax cash outflows of Northwest Lumber under each alternative.
- Find the present value of each after-tax
cash outflow stream, using the after-tax cost of debt - Which alternative-lease or purchase-would you recommend?
Note: Round all the figures to the neares dollar.
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