C.T. All Ltd., a manufacturer of customized baseball souviners, is negotiating with the Grand Slam Company to purchase or to lease a machine that produces foam cushions for seating at baseball parks. The machine would cost $250,000. In five years the machine would have an estimated salvage value of $40,000. Its useful economic life is nine years. These machines have a CCA rate of 20 percent. C.T. All can borrow funds at 13 1/3 percent from its Nearby Bank, and has a tax rate of 25 percent. The capital cost rate on this machine is 9 percent, and C.T. All's cost of capital is 15 percent. Lease payments would be at the beginning of each year, and tax savings would occur at the end of each year. Lease payments would be $64,645.
Should C.T. All Ltd. lease or borrow to purchase the machine? Show your calculations. We note that of all the cash flows, the salvage value has the greatest uncertainty. We recognize this by discounting the salvage value at a higher discount rate-the cost of capital.