Lewis Securities Inc. has decided to acquire a new market data and quotation system for
its Richmond home office.
The system receives current market prices and other
information from several on-line data services, then either displays the information on a
screen or stores it for later retrieval by the firm’s brokers.
The system also permits
customers to call up current quotes on terminals in the lobby.
The equipment costs $1,000,000, and, if it were purchased, Lewis could obtain a term
loan for the full purchase price at a 10 percent interest rate.
Although the equipment has
a six-year useful life, it is classified as a special-purpose computer, so it falls into the
MACRS 3-year class.
If the system were purchased, a 4-year maintenance contract could
be obtained at a cost of $20,000 per year, payable at the
of each year. The
equipment would be sold after 4 years, and the best estimate of its residual value at that
time is $200,000.
However, since real-time display system technology is changing rapidly,
the actual residual value is uncertain.
As an alternative to the borrow-and-buy plan, the equipment manufacturer informed
Lewis that Consolidated Leasing would be willing to write a 4-year guideline lease on the
equipment, including maintenance, for payments of $260,000 at the
Lewis’s marginal federal-plus-state tax rate is 40 percent.
You have been asked to
analyze the lease-versus-purchase decision, and in the process to answer the following
Who are the two parties to a lease transaction?
The two parties are the lessee, who uses the asset, and the lessor, who owns the asset.
What are the five primary types of leases, and what are their characteristics?
The five primary types of leases are operating, financial, sale and leaseback,
combination, and synthetic.
An operating lease, sometimes called a service lease,
provides for both financing and maintenance.
Generally, the operating lease contract
is written for a period considerably shorter than the expected life of the leased
equipment, and contains a cancellation clause.
A financial lease does not provide for
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