Lease versus purchaseNorthwest 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 30% tax bracket, and its after-tax cost of debt is 9%. The terms of the lease and purchase plans are as follows:LeaseThe leasing arrangement requires end-of-year payments of $22,000 over 5 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 $30,000 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.PurchaseIf the firm purchases the machine, its cost of $80,000 will be financed with a 5-year, 18% loan requiring equal end-of-year payments of $25,582. The machine will be depreciated under MACRS using a 5-year recovery period. (See for the applicable depreciation percentages.) The firm will pay $1,000per 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 5-year recovery period.

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

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

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

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Part 1

a. The after-tax cash outflow associated with the lease in years 1 through 4 is $enter your response here. (Round to the nearest dollar.)

Part 2

The after-tax cash outflow associated with the lease in year 5 is $enter your response here. (Round to the nearest dollar.)

Part 3

The after-tax cash outflow associated with the purchase in year 1 is $enter your response here. (Round to the nearest dollar.)

Part 4

The after-tax cash outflow associated with the purchase in year 2 is $enter your response here.

(Round to the nearest dollar.)

Part 5

The after-tax cash outflow associated with the purchase in year 3 is $enter your response here. (Round to the nearest dollar.)

Part 6

The after-tax cash outflow associated with the purchase in year 4 is $enter your response here. (Round to the nearest dollar.)

Part 7

The after-tax cash outflow associated with the purchase in year 5 is $enter your response here. (Round to the nearest dollar.)

Part 8

b. The total present value of the after-tax cash outflows associated with the lease is $enter your response here. (Round to the nearest dollar.)

Part 9

The total present value of the after-tax cash outflows associated with the purchase is $enter your response here. (Round to the nearest dollar.)

Part 10

c.Which alternative would you recommend?

Lease or Purchase

Rounded Depreciation Percentages by Recovery Year Using MACRS for First Four Property Classes
	Percentage by recovery year Superscript a
Recovery year	3 years	5 years	7 years	10 years
1	33%	20%	14%	10%
2	45%	32%	25%	18%
3	15%	19%	18%	14%
4	7%	12%	12%	12%
5		12%	9%	9%
6		5%	9%	8%
7			9%	7%
8			4%	6%
9				6%
10				6%
11				4%
Totals	100%	100%	100%	100%
Superscript aThese percentages have been rounded to the nearest whole percent to simplify calculations while retaining realism. To calculate the actual depreciation for tax purposes, be sure to apply the actual unrounded percentages or directly apply double-declining balance depreciation using the half-year convention.