=+LG 2 P17–5 Lease versus purchase Northwest Lumber Company needs to expand its facilities.

To do so, the firm must acquire a machine costing $80,000. The machine can be leased or purchased. The firm is in the 21% tax bracket, and its after-tax cost of debt is 9%. The terms of the lease and purchase plans are as follows:

Lease The leasing arrangement requires end-of-year payments of $19,800 over 5 years. 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 $24,000 at termination of the lease.

Purchase If the firm purchases the machine, its cost of $80,000 will be financed with a 5-year, 14% loan requiring equal end-of-year payments of

$23,302. The machine will be depreciated under MACRS using a 5-year recovery period. (See Table 4.2 for the applicable depreciation percentages.)

The firm will pay $2,000 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 5-year recovery period.