Case #3: Leasing vs. Buying (20 marks)

Business owners have two financial options (Buying or Leasing) when it comes to obtaining an asset for their company. And like anything in finance, these two monetary alternatives each have their advantages and disadvantages. Q1. What are the pros and cons of leasing a car vs. buying? Q2. Suppose Delta Industries is considering purchasing $45 million in new manufacturing equipment. If it purchases the equipment, it will depreciate it on a straight-line basis over the five years, after which the equipment will be worthless. It will also be responsible for maintenance expenses of $3 million per year. Alternatively, it can lease the equipment for $10 million per year for the five years, in which case the lessor will provide necessary maintenance. Assume Delta Industries tax rate is 40% and its borrowing cost is 8%. Required: a) What is the Net Advantage of Leasing (NAL) associated with leasing the equipment versus financing it with the lease equivalent loan? b) What is the break-even lease ratethat is, what lease amount could Gulf Inc. pay each year and be indifferent between leasing and financing a purchase?