Company requires the use of a machine with the options of buying or leasing. The cost of the machine is K20 million and has a useful life of 5 years with salvage value of K4 million (consider short-term capital loss/gain for the income tax). Option 1: obtain a loan at 20% repayable in five equal installments and repayments falling due at the end of each year. Option 2: lease the machine for five years with year-end lease payments of K6 million per annum. Use decline balance depreciation method at 25%. Company tax is 35% and the cost of capital is 14%.

REQUIRED

I. Advise the company which option it should choose – lease or borrow.

II. Asses the proposal from the lessor’s point of view examining whether leasing the machine is financially viable at 14% cost of capital.