LEASE

(14-7) Lease versus purchase. JLB Corporation is attempting to determine whether to lease or
purchase research equipment. The firm is in the 40 percent tax bracket, and its after tax cost of
debt is currently 8 percent. The terms of the lease & purchase are as follows:
LEASE : Annual end-of-year lease payments of $ 25,200 are required over the 3 years life of
the lease . All maintenance costs will be paid by the lessor; insurance and other costs will be
borne by the lessee. The lessee will exercise its option to purchase the asset for $ 5,000 at
termination of the lease.
PURCHASE : The research equipment, costing of $ 60,000 can be financed entirely with a 14
percent loan requiring annual end-of-year payments of $ 25,844 for 3 years . The firm in this
case will depreciate the truck under MACRS using a 3 year recovery period. The firm will pay $
1,800 per year for a service contract that covers all maintenance costs ; insurance and other costs
will be borne by the firm . The firm plans to keep the equipment and use its beyond its 3 year
recovery period.
REQUIREMENTS:
(a) Calculate the after-tax cash outflows associated with each alternative.
(b) Calculate the present value of each cash outflows stream using the after- tax
cost of debt.
(c) Which alternative , lease or purchase , would you recommend ? Why?

(14-8) Lease versus purchase. Northwest Lumber Company needs to expand its facilities . To
do so, the firm must acquire a machine costing $ 80,000. The machine can be leased or
purchased. The firm is in the 40 percent tax bracket, and its after-tax cost of debt is 9 percent.
The terms of the lease & purchase are as follows:
LEASE : The leasing arrangement requires end-of-year payments of $ 19,800 over 5 years . All
maintenance costs will be paid by the lessor; insurance and other costs will be borne by the
lessee. The lessee will exercise its option to purchase the asset for $ 24,000 at termination of the
lease.
PURCHASE : If the firm purchases the machine , its cost of $ 80,000 will be financed with a 5
year , 14 percent loan requiring equal end –of-year payments of $ 23,302. The machine will be
depreciated under MACRS using a 5 year recovery period. The firm will pay $ 2000 per year for
a service contract that covers all maintenance costs ; insurance and other costs will be borne by
the firm . The firm plans to keep the equipment and use its beyond its 5 – year recovery period.
REQUIREMENTS:
(a) Determine the after-tax cash outflows of Northwest Lumber under each alternative.
(b) Find out the present value of the after tax cash outflows using the after-tax cost of debt.
(c) Which alternative, lease or purchase, would you recommend? Why?