Question

Eastern Trucking Company needs to expand its facilities. In order to do so, the firm must acquire a machine costing $80,000. The machine can be leased or purchased. The firm is in the 40% tax bracket, and its after-tax cost of debt is 5.4%. The terms of the lease and purchase plans are as follows:
Lease. The leasing arrangement requires beginning-of-year payments of $16,900 over five years. The lessee will exercise its option to purchase the asset for $20,000, to be paid along with the final lease payment.
Purchase. If the firm purchases the machine, its cost of $80,000 will be financed with a 5-year, 9% loan requiring equal end-of-year payments of $20,567. The machine will be depreciated on a straight-line bases for five years. The firm plans to keep the equipment and use it beyond its 5-year recovery period.
Determine the after-tax cash outflows of Eastern Trucking under each alternative.
Find the present value of the after-tax cash outflows for each alternative using the after-tax cost of debt.
Which alternative—lease or purchase—would you recommend? Why?


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  • CreatedMarch 26, 2015
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