Question $27(25$ marks$)$

Morris$-$Meyer Mining Company must install $$1\mathrm{.}5$ million of new machinery in its Nevada mine. It can obtain a bank loan for $100$ percent of the required amount. Alternatively, a Nevada investment banking firm that represents a group of investors believes that it can arrange for a lease financing plan. Assume that the following facts apply:

The equipment falls into the MACRS $3-$year class.

Estimated maintenance expenses are $$75,000$ per year $($whether buying or leasing$)$ payable at the end of the year.

Morris$-$Meyer's federal tax rate is $40$ percent.

If the money is borrowed, the bank loan will be at a rate of $15$ percent, amortized in $4$ equal installments to be paid at the end of each year.

The tentative lease terms call for end of year payments of $$400,000$ per year for $4$ years.

Under the proposed lease terms, the lessee must pay for insurance, property taxes, and maintenance.

Morris$-$Meyer must use the equipment if it is to continue in business, so it will almost certainly want to acquire the property at the end of the lease. If it does, then under the lease terms, it can purchase the machinery at its fair market value at that time. The best estimate of this market value is the $$250,000$ salvage value, but it could be much higher or lower under certain circumstances.

Required:

Assuming that the lease can be arranged, should Morris$-$Meyer lease, or should it buy? What is the Net Advantage to leasing $($NAL$).$

Note the MACRS $3-$year class rates are: year $1=0\mathrm{.}33$; year $2=0\mathrm{.}45$; year $3=0\mathrm{.}15.$ year $4=0\mathrm{.}07$