Management of Baldwin Equipment Inc. is considering increasing the productivity of its plant. Management heard from suppliers that a certain piece of equipment could have an after-tax cash flow savings of more than $35,000 a year if it was installed in Baldwin’s plant. However, Jim Henderson, the controller of the company, is unsure whether the company should buy or lease the equipment. If the asset is leased for a 10-year period, it would cost the company $45,000 a year (before tax). The company’s income tax rate is 50%. If the company buys the asset, it would cost $300,000 and be financed entirely through debt for 10 years at a cost of 10%. The asset’s capital cost allowance is 25% (declining basis). On the basis of this information, Jim is now considering whether to purchase or lease the equipment. He is considering doing a sensitivity analysis regarding the two options by modifying some of the data in the information presented above.
On the basis of the following, calculate the effect that each individual change would have on the decision. Changes to the base case (the information given above) are as follows:
Capital cost allowance would be increased to 40%.
The interest on the loan would be 8%.
The company would be able to sell the asset for $50,000 in the tenth year.
As shown below, on an after-tax basis, there would be a net advantage to leasing the asset, $225,000 versus $253,973 for a new difference of $28,973.