a. (1) What is the present value cost of owning the equipment?

(2) Explain the rationale for the discount rate you used to find the PV.

b. What is Lewis's present value cost of leasing the equipment?

c. What is the net advantage to leasing (NAL)? Does your analysis indicate that Lewis should buy or lease the equipment? Explain.

d. Now assume that the equipment's residual value could be as low as $0 or as high as $400,000, but that $200,000 is the expected value. Since the residual value is riskier than the other cash flows in the analysis, this differential risk should be incorporated into the analysis. Describe how this could be accomplished. (No calculations are necessary, but explain how you would modify the analysis if calculations were required.) What effect would increased uncertainty about the residual value have on Lewis's lease-versus-purchase decision?

e. The lessee compares the cost of owning the equipment with the cost of leasing it. Now put yourself in the lessor's shoes. In a few sentences, how should you analyze the decision to write or not write the lease?

f. (1) Assume that the lease payments were actually $280,000 per year, that Consolidated Leasing is also in the 40 percent tax bracket, and that it also forecasts a $200,000 residual value. Also, to furnish the maintenance support, Consolidated would have to purchase a maintenance contract from the manufacturer at the same $20,000 annual cost, again paid in advance. Consolidated Leasing can obtain an expected 10 percent pre-tax return on investments of similar risk. What would Consolidated's NPV and IRR of leasing be under these conditions?

(2) What do you think the lessor's NPV would be if the lease payments were set at $260,000 per year?

g. Lewis's management has been considering moving to a new downtown location, and they are concerned that these plans may come to fruition prior to the expiration of the lease. If the move occurs, Lewis would buy or lease an entirely new set of equipment, and hence management would like to include a cancellation clause in the lease contract. What impact would such a clause have on the riskiness of the lease from Lewis's standpoint? From the lessor's standpoint? If you were the lessor, would you insist on changing any of the lease terms if a cancellation clause were added? Should the cancellation clause contain any restrictive covenants and/or penalties of the type contained in bond indentures or provisions similar to call premiums?

Lewis Securities Inc. has decided to acquire a new market data and quotation system for its Richmond home office. The system receives current market prices and other information from several online data services and then either displays the information on a screen or stores it for later retrieval by the firm's brokers. The system also permits customers to call up current quotes on terminals in the lobby.

The equipment costs $1,000,000 and, if it were purchased, Lewis could obtain a term loan for the full purchase price at a 10% interest rate. Although the equipment has a 6-year useful life, it is classified as a special-purpose computer and therefore falls into the MACRS 3-year class. If the system were purchased, a 4-year maintenance contract could be obtained at a cost of $20,000 per year, payable at the beginning of each year. The equipment would be sold after 4 years, and the best estimate of its residual value is $200,000. However, because real-time display system technology is changing rapidly, the actual residual value is uncertain.