14.

a. What is a lease-equivalent loan? Why is it inappropriate to compare leasing to buying? (4 marks)

b. Emerald City Paints plans to purchase or lease $11.6 million worth of new manufacturing equipment. If purchased, the equipment will be depreciated on a straight-line basis over four years, after which the equipment will be worthless. Emerald City Paints will also be responsible for the maintenance expenses of $1 million per year. Alternatively, it can lease the equipment for $4.4 million per year for the four years, in which case the lessor will provide necessary maintenance. Assume Emerald City Paints borrowing cost is 7% per annum, its tax rate is 35%, the lease qualifies as a true tax lease, and the lease payments are made at the beginning of each year.

Is Emerald City Paints better off leasing the equipment or financing the purchase using the lease-equivalent loan? Why? (6 marks)