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Lease versus purchase JLB Corporation is attempting to determine whether to lease or purchase research equipment.

The firm is in the 21% tax bracket, and its after-tax cost of debt is currently 8%. The terms of the lease and of the purchase are as follows:

Lease Annual end-of-year lease payments of $25,200 are required over the 3-year life of the lease. All maintenance costs will be paid by the lessor; insurance and other costs will be borne by the lessee. The lessee will exercise its option to purchase the asset for $5,000 at termination of the lease.

Purchase The research equipment, costing $60,000, can be financed entirely with a 14% loan requiring annual end-of-year payments of $25,844 for 3 years. The firm in this case will depreciate the equipment under MACRS using a 3-year recovery period. (See Table 4.2 for the applicable depreciation percentages.) The firm will pay $1,800 per year for a service contract that covers all maintenance costs; insurance and other costs will be borne by the firm. The firm plans to keep the equipment and use it beyond its 3-year recovery period.

Table 4.2

Percentage by Recovery Year

Recovery Year 3 years 5 years 7 years 10 years

1 33% 20% 14% 10%

2 45 32 25 18

3 15 19 18 14

4 7 12 12 12

5 12 9 9

a) Calculate the after-tax cash outflows associated with each alternative

b) Calculate the present value of each outflow stream, using the after tax cost of debt.

c) Which alternative-lease or purchase-would you recommend? Why?

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