Problem: MNO Emergency Services Inc. is negotiating a guideline lease for five new ambulances with Leasing International. MNO has received its best offer from Betterbilt Ambulances for a total price of $1 million. The terms of the lease offered by International Leasing call for a payment of $205,000 at the beginning of each year of the five-year lease. As an alternative to leasing, MNO can borrow from
a large insurance company and buy the ambulances. The $1 million would be borrowed on a term loan at a 10 percent interest rate for five years. The ambulances fall into the MACRS five-year class and have an expected residual value of $200,000. Maintenance costs would be included in the lease. If the ambulances are owned, a maintenance contract would be purchased at the beginning of each year for $10,000 per year. MNO plans to buy a new fleet of ambulances at the end of the fifth year. Leasing International has a 40 percent tax rate while MNO has a tax rate of 20 percent.
Q1. What is the present value of the cost of owning the ambulances to MNO?
Q2. What is the present value of the cost of leasing the ambulances to MNO?
Q3. What is the net advantage to leasing? Should MNO lease or buy the ambulances?