Lease versus purchase Northwest Lumber Company needs to expand its facilities. To do so$,$ the firm must acquire a machine costing $$80,000.$ The machine can be leased or purchased. The firm is in the $21\%$ tax bracket, and its after$-$tax cost of debt is $9\%.$ The terms of the lease and purchase plans are as follows:

Lease The leasing arrangement requires end$-$of$-$year payments of $$21,500$ over five years. All maintenance costs will be paid by the lessor; insurance and other costs will be borne by the lessee. The lessee will exercise its option to purchase the asset for $$22,000$ at termination of the lease. Ignore any future tax benefit associated with the purchase of the equipment at the end of year $5$ under the lease option.

Purchase If the firm purchases the machine, its cost of $$80,000$ will be financed with a five$-$year, $17\%$ loan requiring equal end$-$of$-$year payments of $$25,005.$ The machine will be depreciated under MACRS using a $5-$year recovery period. $($See for the applicable depreciation percentages.$)$ The firm will pay $$2,500$ 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 five$-$year recovery period.

a$.$ Determine the after$-$tax cash outflows of Northwest Lumber under each alternative.

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

c$.$ Which alternative$-$lease or purchase$-$would you recommend?

Data table

Rounded Depreciation Percentages by Recovery Year Using MACRS for First Four Property Classes

$\backslash$table$[[,$Percentage by recovery year ${?}^a,],[$Recovery$,3$ years,$5$ years,$7$ years,$10$ years$],[$year$,,20\%,14\%,10\%$