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LG (2 P17-4 LEASE VERSUS PURCHASE JLB Corporation is attempting to determine whether to lease or purchase research equipment. The firm is in the 21%
LG (2 P17-4 LEASE VERSUS PURCHASE JLB Corporation is attempting to determine whether to lease or purchase research equipment. The firm is in the 21% tax bracket, and its after-tax cost of debt is currently 8%. The terms of the lease and of the purchase are as follows: LEASE Annual end-of-year lease payments of $25,200 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 $5,000 at termination of the lease. PURCHASE The equipment costs $60,000 and can be financed with a 14% loan requiring annual end-of-year payments of $25,844 for three years. JLB will depreciate the equipment under MACRS using a three-year recovery period. (See Table 4.2[ 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 JLB, who 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. 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
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