Kris Crawford, capital acquisitions manager for Heath Financial Services Inc., has been asked to perform a lease-versus-buy analysis on a new stock price quotation system for Heath’s Sarasota branch office. The system would receive current prices, record the information for retrieval by the branch’s brokers, and display current prices in the lobby. The equipment costs $1,200,000, and, if it is purchased, Heath could obtain a term loan for the full amount at a 10 percent cost. The loan would be amortized over the four-year life of the equipment, with payments made at the end of each year. The equipment is classified as special purpose, and hence it falls into the MACRS 3-year class. If the equipment is purchased, a maintenance contract must be obtained at a cost of $25,000, payable at the beginning of each year. After four years, the equipment will be sold, and Crawford’s best estimate of its residual value at that time is $125,000. Because technology is changing rapidly in real-time display systems, however, the residual value is uncertain. As an alternative, National Leasing is willing to write a four-year lease on the equipment, including maintenance, for payments of $340,000 at the beginning of each year. Heath’s marginal tax rate is 40 percent. Help Crawford conduct her analysis by answering the following questions:
a. (1) Why is leasing sometimes referred to as off-balance-sheet financing? (2) What is the difference between a capital lease and an operating lease? (3) What effect does leasing have on a firm’s capital structure?
b. (1) What is Heath’s present value cost of owning the equipment?  (2) Explain the rationale for the discount rate you used to find the present value.

c. (1) What is Heath’s present value cost of leasing the equipment? (2) What is the net advantage to leasing? Does your analysis indicate that Heath should buy or lease the equipment? Explain.
d. Now assume that Crawford believes the equipment’s residual value could be as low as $0 or as high as $250,000, but she stands by $125,000 as her expected value. She concludes that the residual value is riskier than the other cash flows in the analysis, and she wants to incorporate this differential risk into her analysis. Describe how this could be accomplished. What effect would it have on Heath’s lease decision?
e. Crawford knows that her firm has been considering moving to a new downtown location for some time, and she is concerned that these plans might come to fruition prior to the expiration of the lease. If the move occurs, the company would obtain completely new equipment, and hence Crawford would like to include a cancellation clause in the lease contract. What effect would a cancellation clause have on the riskiness of the lease?