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Unformatted text preview: le to maintenance, depreciation, and
Step 3 Calculate the present value of the cash outflows associated with the lease
(from Step 1) and purchase (from Step 2) alternatives using the after-tax
cost of debt as the discount rate. The after-tax cost of debt is used to
evaluate the lease-versus-purchase decision because the decision itself
involves the choice between two financing techniques—leasing and borrowing—that have very low risk.
Step 4 Choose the alternative with the lower present value of cash outflows
from Step 3. This will be the least-cost financing alternative.
The application of each of these steps is demonstrated in the following example.
EXAMPLE Roberts Company, a small machine shop, is contemplating acquiring a new
machine that costs $24,000. Arrangements can be made to lease or purchase the
machine. The firm is in the 40% tax bracket.
Lease The firm would obtain a 5-year lease requiring annual end-of-year lease
payments of $6,000.2 All maintenance costs would be paid by the lessor, and
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- Fall '13