Question 3: (20 marks)

RPC Creative Works is evaluating a potential lease agreement for a printing machine that costs$ 100,000 This machine would be able to reduce production cost in printing of buntings ando ther outdoor promotional items by 25%.

The leasing proposal calls for four annual payments of $30,000 to be made at the beginningo f the year. The lessor will assume all costs pertaining to maintenance and insurance should PC opt for the leasing arrangement. RPC intends to exercise the option to purchase the asset t the end of lease contract for $5.000

RPC is also considering purchasing the machine by utilizing the standby credit facility made available to them by their banker, should the company decide to buy the asset rather than lease t. For machinery purchase, RPCs banker is offering a 4-year term loan financing at 10%I nterest on a yearly reducing balance. Instalment payments are to be made annually.

If RPC buys the machine, it will have to purchase a maintenance contract that costs $5,000

a year, payable at the end of each year, with the machine supplier.

RPC would also have to purchase an insurance policy for the new machine. Its insurance broker rovided the following information on the insurance coverage:

Annual premium is based on the rate of 2% of the insured value.

Annual premium is to be paid at the beginning of the year.

For determining the insured value, the market value of the machine is assumed to be thes inured value. Best estimates for the machine market value, obtained from RPC panel of registered valuer are given below:

Year 2 =$75,000; Year 3 =$50,000; Year 4 =$20,000

The initial premium amount is based on the cost of the machine at time of purchase

This machine falls into the MACRS 3-year class, with its applicable MACRS depreciation rates

of 33%, 45%, 15% and 7%. The applicable tax rate is 30 percent.

Should RPC lease or buy? Explain

.

[Total: 20 marks]

N.B: Round to the nearest whole number for all calculations. For rate of return, use 2- decimal places.