Suppose Clorox can lease a new computer data processing system for

$950,000

per year for five years. Alternatively, it can purchase the system for

$ 4.35

million. Assume Clorox has a borrowing cost of

6%

and a tax rate of

35%,

and the system will be obsolete at the end of five years.

a.

If Clorox will depreciate (for tax purposes) the computer equipment on a straight-line basis over the next five years and if the lease qualifies as a true tax lease, is it better to finance the purchase of the equipment or to lease it?

b. Suppose that if Clorox buys the equipment, it will use accelerated depreciation for tax purposes. Specifically, the CCA rate will be

45%

and any undepreciated capital cost in year 6 will be taken as a terminal loss. Compare leasing with purchase in this case.