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 40% 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 $19,800 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 $24,000 at the termination of the lease.

Purchase: If the firm purchases the machine, its cost of $80,000 will be financed with a 5-year, 14% loan requiring end-of-year payments of $23,302. The machine will be depreciated under MACRS using a 5-year recovery period. The firm will pay $2,000 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 5-year recovery period.

• Determine the after-tax cash outflows of Northwest Lumber under each alterative.
• Find the present value of each after-tax cash outflow stream, using the after-tax cost of debt.
• Which alternative (lease or purchase) would you recommend? Why?

MACRS Schedule for a 5-year asset

Recovery Year	Percentage Allowed
1	20%
2	32%
3	19%
4	12%
5	12%
6	5%