1. Annular Eclipse Viewer Company (AEV Co.) is considering an investment in new technology that will reduce operating costs through increasing energy efficiency and decreasing pollution. The new technology will cost Birr 1 million and have a four-year life at the end of which it will have a scrap value of Birr 100,000.

A license fee of Birr 104,000 is payable at the end of the fiscal year. The license fee will increase by 4% per year in each subsequent year.

The new technology is expected to reduce operating costs by Birr5.80 per unit in current price terms. This reduction in operating costs is before taking account of expected inflation of 5% per year.

Forecast production volumes over the life of the new technology are expected to be as follows:

Year 1 2 3 4

Production (units per year) 60,000 75,000 95,000 80,000

If the company bought the new technology, it would finance the purchase through a four year loan paying interest at an annual before tax rate 8.6% per year from Abay Bank.

Alternatively, AEV Co. could lease the new technology from Waliya capital lease. The company would pay four annual lease rentals of Birr380,000 per year payable in advance at the start of each year. The annual lease rentals include the cost of the license fee.

If AEV Co. buys the new technology, it can claim capital allowance (allowable depreciation) on the investment on a 25% reducingbalance bases (depreciation is on the remainingvalue). AEV Co. is operating in Ethiopia and is required to act according to the Ethiopian corporate tax lows which mean tax rate is 30% and payment is one year in arrears. AEV Co. has an after tax weighted average cost of capital of 11% per year.

Required:

1. Based on financing cash flows only, calculate and determine whether AEV Co. should lease or buy the new technology