GMS Corporation is attempting to determine whether to lease or purchase research equipment. The firm is in the 40% tax bracket, and its after-tax cost of debt is currently 6%. The terms of the lease and the purchase are as follows:
Lease. Annual beginning-of-year lease payments of $93,500 are required over the 3-year life of the lease. The lessee will exercise its option to purchase the asset for $25,000, to be paid along with the final lease payment.
Purchase. The $250,000 cost of the research equipment can be financed entirely with a 10% loan requiring annual end-of-year payments of $100,529 for three years. The firm in this case will depreciate the equipment using the straight-line method for three years. The firm plans to keep the equipment and use it beyond its 3-year recovery period.
a. Calculate the after-tax cash outflows associated with each alternative.
b. Calculate the present value of each cash outflow stream using the after-tax cost of debt.
c. Which alternative—lease or purchase—would you recommend? Why?

  • CreatedMarch 26, 2015
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