Company requires the use of a machine with the options of buying or leasing. The cost of
Question:
Company requires the use of a machine with the options of buying or leasing. The cost of the machine is K20 million and has a useful life of 5 years with salvage value of K4 million (consider short-term capital loss/gain for the income tax). Option 1: obtain a loan at 20% repayable in five equal installments and repayments falling due at the end of each year. Option 2: lease the machine for five years with year-end lease payments of K6 million per annum. Use decline balance depreciation method at 25%. Company tax is 35% and the cost of capital is 14%.
REQUIRED
I. Advise the company which option it should choose – lease or borrow.
II. Asses the proposal from the lessor’s point of view examining whether leasing the machine is financially viable at 14% cost of capital.
Engineering Economy
ISBN: 978-0132554909
15th edition
Authors: William G. Sullivan, Elin M. Wicks, C. Patrick Koelling