1. Assuming 0% taxes. Equipment can be leased at $12000 per year (first payment at end of year) for nine years or purchased at a cost of $68000. The company has a weighted average cost of capital of 12%. A bank has indicated that it would be willing to make the loan of $68000 at a cost of 10%. There is no salvage value. Assume a marginal tax rate of 40% and that a loan can be obtained from the bank at a cost of 9%. Should the firm buy or lease? The PV of the depreciation expense is 60% of the original investment. Assume a 5.4% discount rate.
A Lease; PV of Lease option lower than Buy option
B Lease; PV of Buy option lower than Lease option
C Buy; PV of Buy option lower than Lease option
D none of them
E Buy; PV of Lease option lower than Buy option
2. Referring to Q1. If the lease payments start at the beginning of the year, would your recommendation change? How?
A Buy; PV of Buy option lower than Lease option
B Lease; PV of Lease option lower than Buy option
C Lease; PV of Buy option lower than Lease option
D Buy; PV of Lease option lower than Buy option
E none of them