It is January, and Ms. Deb. T. Laden, president of Debt Laden Inc. (Debt Laden), has just returned from an annual visit with the company’s banker, Mr. Green, to present Debt Laden’s December financial statements. Mr. Green expressed concern over Debt Laden’s profitability and debt level. In an effort to alleviate Mr. Green’s concerns, Ms. Laden proposed to sell a major piece of production equipment to a local finance company, provided Debt Laden is able to lease it back. The equipment was purchased two years ago from a Japanese manufacturer for $1,000,000 and is being depreciated at 15% per year on a declining-balance basis. Due to the rise in the value of the Japanese yen relative to the Canadian dollar, Ms. Laden estimates that the machinery is currently worth $1,500,000. 

She has approached Mr. Fin, president of Sharky’s Financial Services Ltd. (Sharky’s), who indicated that he would be willing to purchase the equipment for $1,500,000 and lease it back to Debt Laden for $274,252 per year for the next 10 years, payable at the end of each year. Debt Laden would have the option to repurchase the asset at the end of the lease term at its estimated fair value of $500,000, as it would be usable for at least another five years. Ms. Laden thinks Sharky’s is getting a pretty good deal, as she estimates Debt Laden’s cost of capital to be 12%. However, Mr. Fin indicated over lunch, “Hey, I gotta earn 15% or I just don’t make no money on this lease!”

Ms. Laden is eager to complete the transaction in an effort to improve the company’s profitability (by recording the gain on the sale of the equipment) and to concurrently reduce the company’s debt level (by using the sale proceeds to pay down a loan of $1,500,000 with a 12% interest rate). 

Required:

Analyze the above information and provide your recommendation to Ms. Laden as to whether she should undertake the proposed transaction.