L9 assignment - Wolfson Corporation has decided to purchase...

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Wolfson Corporation has decided to purchase a new machine that costs $3.2 million. The machine will be depreciated on a straight-line basis and will be worthless after four years. The corporate tax rate is 35 percent. The Sur Bank has offered Wolfson a four-year loan for $3.2 million. The repayment schedule is four yearly principal repayments of $800,000 and an interest charge of 9 percent on the outstanding balance of the loan at the beginning of each year. Both principal repayments and interest are due at the end of each year. Cal Leasing Corporation offers to lease the same machine to Wolfson. Lease payments of $950,000 per year are due at the beginning of each of the four years of the lease. a. Should Wolfson lease the machine or buy it with bank financing? b. What is the annual lease payment that will make Wolfson indifferent to whether it leases the machine or purchases it? SOLUTION The decision to buy or lease is made by looking at the incremental cash flows. The loan offered by the bank merely helps you to establish the appropriate discount rate.
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