Question
A firm has to replace a machine using either of the following machines: machine X that is available only on a lease basis and machine
A firm has to replace a machine using either of the following machines: machine X that is available only on a lease basis and machine Y that is available for a purchase cost of $365,000. The lease payments for machine X will be $80,000 for 5 years, due at the beginning of each year and machine X saves $29,000 per year through reductions in electricity costs. Machine Y, which is more energy-efficient, saves $32,000 per year on electricity costs. A local bank has offered to finance the machine with a loan. The interest rate on the loan will be 10% on the remaining balance and will require 5 annual principal payments of $73,000. The firm has a target debt-asset ratio of 67% and faces a tax rate of 21%. Both machine X and machine Y will be worthless after 5 years and both machines will be depreciated on a straight-line basis.
i) Should this firm lease machine X or buy machine Y?
ii) How much debt is displaced by this lease?
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