Riverton Mining plans to purchase or lease $220,000 worth of excavation equipment. If purchased, the equipment will be depreciated on a straight-line basis over five years, after which it will be worthless. If leased, the annual lease payments will be $55,000 per year for five years.
Assume Riverton’s borrowing cost is 8%, its tax rate is 35%, and the lease qualifies as a true tax lease.
a. If Riverton purchases the equipment, what is the amount of the lease-equivalent loan?
b. Is Riverton better off leasing the equipment or financing the purchase using the lease-equivalent loan?
c. What is the effective after-tax lease borrowing rate? How does this compare to Riverton’s actual after-tax borrowing rate?