The CSI development corporation, has a wood refining business. They need a new machine to remain competitive.
Question:
The CSI development corporation, has a wood refining business. They need a new machine to remain competitive. This machine if purchased would cost $80,000. The same machine can be leased as well. The after-tax cost of debt for the company is 9%, and the company’s corporate tax rate is 40%. The following are the terms applicable to the lease and purchase scenarios:
Lease: Leasing the machine would require end-of-the year payments of $19,000 over a 5 year period. The maintenance cost will be paid by the lessor, while the insurance of cost cost will be the responsibility of the lessee. At the end of the lease period you should assume that the lessee will exercise its option to purchase the asset for $24,000.
Purchase: If the company decides to purchase the machine it will finance the purchase with a 14%, 5 year term loan. The machine will be depreciated under MACRS using a 5-year recovery period. The company’s service contract will cost them $2,000 per year for the machine. The company intends to keep the machine and use it beyond its 5 year recovery period.
- What are the after-tax cash outflows of the company under each scenario?
- Find the present value of the after-tax cash flows using the after-tax cost of debt.
- Which alternative would you recommend?
lease | Purchase |
After-tax cash flows | After-tax cash flows |
1) | 1) |
2) | 2) |
3) | 3) |
4) | 4) |
5) | 5) |
Present Value of AT cash flows | Present Value of AT cash flows |
1) | 1) |
Which alternative is best? |
Management information systems
ISBN: 978-0073376813
10th edition
Authors: James A. O Brien, George M. Marakas