JLB Corporation is attempting to determine whether to lease or purchase research equipment. The firm is in the 25% tax bracket, and its after-tax cost of debt is currently 9%. The terms of the lease and of the purchase are as follows:

LeaseAnnual end-of-year lease payments of $27,000 are required over the three-year life of the lease. All maintenance costs will be paid by the lessor; insurance and other costs will be borne by the lessee. The lessee will exercise its option to purchase the asset for $7,000 at termination of the lease. Ignore any future tax benefit associated with the purchase of the equipment at the end of year 3 under the lease option.

PurchaseThe equipment costs $65,000 and can be financed with a 14% loan requiring annual end-of-year payments of $27,998 for three years. JLB will depreciate the equipment under MACRS using a three-year recovery period. (See LOADING... for the applicable depreciation percentages.) JLB will pay $1,800 per year for a service contract that covers all maintenance costs; insurance and other costs will be borne by the firm. The firm plans to keep the equipment and use it beyond its three-year recovery period.

a.Calculate the after-tax cash outflows associated with each alternative.(Hint: Because insurance and other costs are borne by the firm under both alternatives, those costs can be ignored here.)

b. Calculate the present value of each stream, using the after-tax cost of debt.

c.Which alternative lease or purchase would you recommend? Why?