A company has decided to acquire a K5 million machine with a useful life of 10 years. A subsidy of K500,000 is available at the time the machine is acquired and put into service. The machine would be depreciated on a straight –line basis and no salvage value is expected. The company corporate tax is 50%.

The acquisition could be financed with a lease, with lease annual payments of K550,000 required at the beginning of each year. Alternatively the company can obtain a loan and purchase the machine at interest rate of 10%. The loan is payable in equal instalments and the debt payment would be due at the beginning of each year.

1. a. What is the present value of cash outflow for each of the two financing options, using the after-tax cost of debt?
2. b. Which of the two alternatives is preferable?

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