4. The lessee's lease analysis

Consider the case of Shoe Building Inc. (SBI):

Shoe Building Inc. (SBI) is considering the purchase of new manufacturing equipment that will cost $10,000 (including shipping and installation). SBI can take out a four-year, $10,000 loan to pay for the equipment at an interest rate of 2.40%. The loan and purchase agreements will also contain the following provisions:

•	The annual maintenance expense for the equipment is expected to be $100.
•	The equipment has a four-year depreciable life. The Modified Accelerated Cost Recovery System’s (MACRS) depreciation rates for a three-year asset are 33.33%, 44.45%, 14.81%, and 7.41%, respectively.
•	The corporate tax rate for SBI is 40%.

Note: Shoe Building Inc. (SBI) is allowed to take a full-year depreciation tax-saving deduction in the first year.

Based on the preceding information, complete the following tables:

	Value
Annual tax savings from maintenance will be:

	Year 1	Year 2	Year 3	Year 4
Tax savings from depreciation
Net cash flow

Thus, the net present value (NPV) cost of owning the asset will be:

-$14,086

$7,676

-$5,844

-$6,342

Shoe Building Inc. (SBI) has been offered an operating lease on the same equipment. The four-year lease requires end-of-year payments of $400, and the firm will have the option to buy the asset in four years for $2,200. The firm will want to use the equipment longer than four years, so it plans to exercise this option. All maintenance will be provided by the lessor. What is the NPV cost of leasing the asset?

-$700

-$9,300

-$3,755

-$3,004

Should SBI lease or buy the equipment?

Lease

Buy

Answer rating: 100% (QA)

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