T4 Enterprises develops sophisticated communications equipment for government and commercial use. It is organized into two divisions, which are evaluated as investment centers. The cost of capital used in evaluating the divisions is 12 percent.

A local startup has developed and patented a process that significantly shortens production times. The startup has offered to either sell the patent to T4’s Government Division (GD) or to lease the exclusive rights to the process. (The process is not usable in the Commercial Division). The lease (and the estimated economic life of the process) is seven years. If purchased, the technology would cost $3.8 million. A seven-year lease would require annual payments of $1,015,000.

The division manager of GD estimates that annual income using the process (before considering any depreciation or lease payments) would be $5 million. The investment for GD (before considering any impact from the new technology) is $30 million.

Assume that the patent would be amortized on a straight-line basis if purchased. Ignore any income tax effects.


Required
a. Suppose the manager of GD is evaluated using return on investment (ROI). Will she prefer to lease or purchase the technology?
b. Suppose the manager of GD is evaluated using residual income. Will she prefer to lease or purchase the technology?
c. Suppose the manager of GD is evaluated using return on investment (ROI). What is the lease payment that would make the manager indifferent between leasing and purchasing the technology?
d. Suppose the manager of GD is evaluated using residual income. What is the lease payment that would make the manager indifferent between leasing and purchasing the technology?

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