1. Lease versus purchase ABC Shop wishes to evaluate two plans for financing an oven: leasing and borrowing to purchase. The firm is in the 40% tax bracket.

Lease The shop can lease the oven under a 5-year lease requiring annual end-ofyear payments of $5,000. All maintenance costs will be paid by the lessor, and insurance and other costs will be borne by the lessee. The lessee will exercise its option to purchase the asset for $4,000 at termination of the lease.

Purchase The oven costs $20,000 and will have a 5-year life. It will be depreciated under MACRS using a 5-year recovery period. (See Table 4.2 on page 166 for the applicable depreciation percentages.) The total purchase price will be financed by a 5-year, 15% loan requiring equal annual end-of-year payments of $5,967. The firm will pay $1,000 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. a. For the leasing plan, calculate the following: (1) The after-tax cash outflow each year. (2) The present value of the cash outflows, using a 9% discount rate. b. For the purchasing plan, calculate the following: (1) The annual interest expense deductible for tax purposes for each of the 5 years. (2) The after-tax cash outflow resulting from the purchase for each of the 5 years. (3) The present value of the cash outflows, using a 9% discount rate. c. Compare the present values of the cash outflow streams for these two plans, and determine which plan would be preferable. Explain your answer.