(b) Would such lease be classified as capital or an operating lease? Briefly explain. (1 mark)

(c) Identify the relevant incremental after-tax cash flows from leasing over purchasing in years 0- 4. Neatly present and label ALL relevant incremental after-tax cash flows in a table. (5 marks)

Mila Limited (ML) is considering whether to lease or purchase a piece of equipment. The following information is relevant to these options:

Buy: The purchase price of the machine is $4 million. The machine would be straight-line depreciated to a zero salvage value over 4 years. The residual value is expected to be zero.

Lease: The annual lease payments requested by Michal Leasing Inc. (the lessor) would be $1 million, payable at the end of each of the 4 years of the lease.

Additional information: Corporate tax rate is 35% for both companies, the cost of equity for ML is 25%, the cost of secured debt for ML is 10% and its WACC is 17%. The cost of secured debt for Michal Leasing Inc. is 6%.