Mini Case

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.

As an alternative to the borrow$-$and$-$buy plan, the equipment manufacturer informed

Lewis that Consolidated Leasing would be willing to write a $4-$year guideline lease on

the equipment, including maintenance, for payments of $$260,000$ at the beginning of

each year. Lewis's marginal federal$-$plus$-$state tax rate is $25\%.$ You have been asked to

analyze the lease$-$versus$-$purchase decision and, in the process, to answer the following

questions.

a$.(1)$ Who are the two parties to a lease transaction?

$(2)$ What are the four primary types of leases, and what are their characteristics?

$(3)$ How are leases classified for tax purposes?

$(4)$ What effect does leasing have on a firm's balance sheet?

$(5)$ What effect does leasing have on a firm's capital structure?