1. Lease and buy decisions in capital budgeting

Tip construction Ltd. has decided to purchase a new machine that costs US 3 million. The machine will be worthless after 3 years and will be depreciated on a straight line basis.

Standard Charter Bank has offer Tip construction Ltd. a 3 year loan of US 3 million. The repayment schedule is composed of 3 three--yearly principal repayments of US 1 million and an interest charge at the rate of 12% per annum on the outstanding balance of the loan at the beginning of each year. The market wide rate of interest is 12% per annum. Both principal repayments and interest are due at the end of each year.

Chris leasing Ltd. offers to lease the same machine to Tip construction Ltd. The lease payments of US 1.2 million per year are due at the end of each of the 3 years of the lease.

The corporate tax is 39%.

Required:

Advise Tip construction Ltd. on whether it should lease the machine or buy it with bank financing, based on your calculation.