SECTION B-Problem 4 (10 points)

Sadik Industries must install $2.5 million of new machinery in its Texas plant. It can obtain a bank loan for 100% of the required amount. Alternatively, a Texas investment banking firm that represents a group of investors believes that it can arrange for a lease financing plan. Assume that these facts apply: i. The equipment falls in the MACRS 3-year class. ii. Estimated maintenance expenses are $90,000 per year payable at the end of the year. The firms tax rate is 40%. iii. If the money is borrowed, the bank loan will be at a rate of 10%, amortized in 3 equal installments at the end of each year. iv. The tentative lease terms call for payments of $500,000 at the end of each year for 3 years. The lease is a guideline lease. v. Under the proposed lease terms, the lessor must pay for maintenance, which is tax deductible. vi. The best estimate of the market value of the machine at the end of the lease term is $350,000. Assuming that the lease can be arranged, should the firm lease or borrow and buy the machinery? Give your decision based on the NPV analysis.