Question: Biomedical Labs, is considering whether to lease or buy a part of research equipment costing $150,000. The firm is in the 40 percent tax bracket & its after tax cost of debt is eight percent. The terms of each alternative are as follows:
Lease: 3year term with annual end of year payments of dollar 59,500. The lesser will pay maintenance costs; Biomedical Labs will give for insurance & other costs. It plans to exercise its dollar 25,000 buy option at the end of the lease term.
Purchase: Financed with a three-year, 13 percent term loan with equal end-of-year payments of $63,530. Interest payments are shown below. The test equipment will be depreciated under ACRS using a three-year recovery period. The firm will pay dollar 3,500 per year for a maintenance contract & will also cover insurance & other costs.
|
Year
|
Interest
|
|
1
|
$19,500
|
|
2
|
13,776
|
|
3
|
7,308
|
[A] Compute the after tax cash flows associated with the lease alternative & the after tax cash flows associated with the purchase alternative.
[B] Compute the present value of the cash flows for both the lease & the buying alternatives.
[C] Determine which alternative should Biomedical Labs choose? Explain.