3. The lessee's lease analysis

A lease is an agreement that allows one party to use another partys property, plant, or equipment. Leases have become an important source for financing fixed assets for businesses and consumers.

In a lease agreement, the (Lessee or Lessor) uses the leased assets, which are owned by the (Lessee or Lessor). (Select the correct choices)

Consider the case of Hack Wellington Co. (HWC):

Hack Wellington Co. (HWC) is considering the purchase of new manufacturing equipment with an after-tax cost of $11,250. (The equipment qualifies for 100% bonus depreciation and $11,250 is the investment amount after bonus depreciation has been applied. Since the equipment has been fully depreciated at the time of purchase, there is no annual depreciation expense.) HWC can take out a four-year $11,250 loan to pay for the equipment at an interest rate of 3.60%. The loan and purchase agreements will also contain the following provisions:

The annual maintenance expense for the equipment is expected to be $113.

The corporate tax rate for HWC is 20%.

Based on the preceding information, complete the following tables:

Annual tax savings from maintenance will be: Value - _____

Year 1: Net cash flow

Year 2: Net cash flow

Year 3: Net cash flow

Year 4: Net cash flow

Thus, the net present value (NPV) cost of owning the asset will be:

A. $11,442.97

B. -$11,586.99

C. -$18,054.00

D. -$8,957.00

Hack Wellington Co. (HWC) has been offered an operating lease on the same equipment. The four-year lease requires end-of-year payments of $900, and the firm will have the option to buy the asset in four years for $5,625. The firm will want to use the equipment longer than four years, so it plans to exercise this option. All maintenance will be provided by the lessor. What is the NPV cost of leasing the asset?

A. -$7,705.10

B. -$9,208.70

C. -$9,631.38

D. -$2,041.30

Should HWC lease or buy the equipment?

A. Buy

B. Lease