An existing piece of equipment has been performing poorly and needs replacing. More modern equipment can be purchased, or it can be leased. If purchased, the equipment will cost $20,000 and will have a depreciable life of 5 years with no market value. For simplicity, assume straight line depreciation is used by the firm.

Because of improved operating characteristics of the equipment, raw materials savings of $5,000 per year are expected to result relative to continued use of present equipment. However, annual labour expenses for the new equipment will most likely increase by $2,000 and annual maintenance will go up by $1,000.

To lease the new equipment requires a refundable deposit of $2,000, and the end-of-year leasing fee is $6,000. Annual materials savings and extra labour expenses will be the same when purchasing or leasing the equipment, but the lessee company will provide maintenance for its equipment as part the leasing fee.

The after-tax MARR is 15% per year, and the effective income tax rate is 50%.

If purchased, it is believed that the equipment can be sold at the end of 5 years for $ I,500 even though $0 was used in calculating straight-line depreciation.

Determine whether the company should buy or lease the new equipment, assuming that it has been decided to replace the present equipment.