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(ML) Mila Limited is debating whether to rent or buy a piece of machinery. These choices require the following information:

Buy: The purchase price of the machine is $4 million. The machine would be straight-line depreciated to a zero salvage value over 4 years. The residual value is expected to be zero.

Lease: The annual lease payments requested by Michal Leasing Inc. (the lessor) would be $1 million, payable at the end of each of the 4 years of the lease.

Additional information: Both firms pay a 35 percent corporate tax rate, ML has a 25 percent cost of equity, a 10 percent cost of secured debt, and a 17 percent WACC. The cost of secured debt for Michal Leasing Inc. is 6%.

Questions:

1(a) Should ML lease or purchase the equipment? Conduct NPV (leasing over purchasing) analysis and show your calculation.

1(b) What set of lease payments will make the lessee and the lessor equally well off? (Show your calculations).