Hull Manufacturing Co. must decide whether to purchase or lease a new piece of equipment. The equipment can be leased for $4,000 a year or purchased for $15,000. The lease includes maintenance and service. The salvage value of the equipment at the end of five years is $5,000. If the equipment is owned, service and maintenance charges (a tax-deductible cost) would be $900 a year. The firm can borrow the entire amount at a rate of 15% if they buy. The tax rate is 50%. Which method of financing would you choose?
Use the following capital cost allowance amounts.
Year Amount
1 .......... $4,500
2 .......... 3,150
3 .......... 2,205
4 .......... 1,543
5 .......... 1,081

The purchase option is more economically advantageous. The purchase option costs $5,197 and $10,000 for the lease option.