Lease or Buy analysis

Gamma Tools needs a new automated packaging machine.

---The total cost of the new machine is $2,500,000.

---Gamma will sell the asset at the end of five years for $325,000

---Gamma's marginal tax rate is 21%

Option 1:Borrow and Buy

$275,000 down payment

5 year loan, 8% interest rate

Loan payments made end of year

5 year MACRS depreciation (.20, .32, .19, .12, .12, .05)

Maintenance is estimated to be $75,000 annually

Option 2:Lease

5 year term

$420,000 per year, due at the beginning of the year.

-Consider all relevant cash flows and calculate the PV of option #1 and option #2.

Should Gamma Borrow/Buy or Lease the equipment?