Suppose Procter and Gamble (P&G) is considering purchasing $15 million in new manufacturing equipment. If it purchases the equipment, it will depreciate it on a straight-line basis over the five years, after which the equipment will be worthless. It will also be responsible for maintenance expenses of $1 million per year. Alternatively, it can lease the equipment for $4.2 million per year for the five years, in which case the lessor will provide necessary maintenance. Assume P&G’s tax rate is 35% and its borrowing cost is 7%.
a. What is the NPV associated with leasing the equipment versus financing it with the lease-equivalent loan?
b. What is the break-even lease rate—that is, what lease amount could P&G pay each year and be indifferent between leasing and financing a purchase?