A corporation is trying to decide whether to lease a machine for five years and pay the residual purchase cost to buy the machine in the last year of the lease or buy the machine now. The annual lease payment would be $9,000 with payments made at the beginning of each year. The residual purchase cost would be $25,200 to be paid at the beginning of the fifth year. The lease payments are standard business expenses that reduce the corporation’s tax liability accordingly. $89,300 can be borrowed from the bank to buy the machine now. Annual loan payments would be made for 5 years at a 6%

interest rate. The machine can be fully depreciated in a straight line manner over 5 years. Both the loan interest payment and the depreciation provide tax shields against a corporate tax rate of 40%. The appropriate discount rate for both alternatives is the after-tax cost of debt, where the corporation’s cost of debt is assumed to be the same as the loan rate. Should the corporation lease or buy?