Question
Bandbox is considering a lease vs. buy decision on a large piece of equipment. The equipment will be obsolete after 3-years (no value at end
Bandbox is considering a lease vs. buy decision on a large piece of equipment. The equipment will be obsolete after 3-years (no value at end of life). The company can borrow the funds needed to purchase this equipment at a rate of 10%. The company has a tax rate of 40%. If the company buys the equipment, it will be able to reduce its taxes by $640 million due to depreciation tax savings (interest deductions and a reduction in income due to maintenance also providing tax savings). All together, owning the equipment results in a positive contribution(due to all tax savings) of $208 per year in the first two years. In the third year, cash flow would be negative due to the repayment of the loan. As such, ownership cash flows are estimated to be as follows:
Year1: +208
Year2: +208
Year3: -4,592
Leasing provides fewer tax shields, but no debt. As such, it's cash flows should be the same every year and negative. The cash flows expected if Bandbox leases this equipment would be:
Year1: -1260
Year2: -1260
Year3: -1260
What is the after-tax cost of debt for Bandbox?
What is the NPV of the cash flows from ownership(Use after-tax cost of debt as interest rate)
What is the NPV of the cash flows from leasing?(use after-tax cost of debt as interest rate)
Based upon your answers in the prior 3 problems, should Bandbox buy or lease this equipment?
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