XYZ Storage is evaluating a project which involves producing a new product with an extended marketable life of 4 years. In order to produce this product, the company will have to acquire a piece of new equipment worth $400,000. The company is considering whether it should lease or borrow to purchase the equipment. The opportunity cost of borrowing for an asset which has a purchase price of $400,000 is 15% p.a. Other details of each alternative are provided as follows:

Purchase:

This equipment can be depreciated at 20% reducing balance if owned, and has an expected salvage value of $100,000 after 4 years.

Lease:

If the lease is in advance, there will be four payments of $145,000 made at the beginning of each year and a residual payment of $40,000 made at the end of the term, i.e., at the end of year 4.

The company tax rate is 25%. Calculate the NPV of leasing and advise the company as to whether it should purchase or lease the equipment with payments made in advance?

[Total for Question 3: 8 marks]