A few month's later, Geoff calls you into his office for a discussion. I have been evaluating

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Question:

A few month's later, Geoff calls you into his office for a discussion. "I have been evaluating an upgrade

in our manufacturing equipment. We need a new electrode coater machine, but we must decide whether

to buy or lease it. Maxtech Co. has offered to sell the machine to us for 2.5 Million. Because of the rapid

development of new technology, the equipment falls into class 45 with a CCA rate of 45%. At the end of

four years, the market value of the equipment is expected to be $320,000. Alternatively, Laurie's

Leasing can lease us the machine for four annual payments of $650,000 due at the beginning of the year.

Additionally, Laurie's Leasing requires a $300,000 security deposit that will be returned at the end of the

lease (end of year 4). Should we lease or buy this machine?"

Information from part 1:

You have recently been hired by Intersoll Motors Inc. (IMI) in its relatively new treasury management department. IMI was founded eight years ago by Geoff Boycott. Geoff found a method to manufacture a cheaper battery that will hold a larger charge, giving a car powered by the battery a range of 700 km before requiring a charge. The cars manufactured by IMI are midsized and carry a price that allows the company to compete with other mainstream auto manufacturers. The company is privately owned by Geoff and his family and it had sales of $97 million last year. Cost of goods sold totalled $80M and depreciation was $2M.

IMI's growth to date has come from its profit. When the company had sufficient capital, it would expand production. Relatively little formal analysis has been used in its capital budgeting process. Geoff has just read about capital budgeting technique and has come to you for help. For starters, the company has never attempted to determine its cost of capital, and Geoff would like you to perform the analysis. Because the company is privately owned and not yet publicly traded, base all weights on the book values instead of the market values.

IMI's capital is made up of a bank loan and owner's equity. It has a 15-year loan for 8,000,000 with an APR of 12.15% based on semi-annual compounding. IMI has been paying 95,260 monthly for 8 years. The required return on equity is 20%. The firm's marginal tax rate is 35% and this is expected to continue indefinitely.

QUESTION:

a. What is the NAL of leasing the electrode coater machine? (Use the information from part 1 to calculate your yearly cost of debt.)

b. Should you lease or buy the electrode coater machine?

c. Provide 2 reasons why the lease above is likely a financing/capital lease.