Parting Way Hair Products, Inc. has decided to acquire a piece of equipment that will costs $1 million, including installation costs, and will be depreciated over its five-year useful life using straight-line while providing for an estimated salvage value of $100,000. The firm has considered numerous financing alternatives and has narrowed the choice to the following two:

Borrow $1 million, as a secured loan, from a commercial bank at 10%. The loan would require five equal payments commencing one year from now.

Lease the equipment from the manufacturer. The arrangement would be noncancellable and require five equal annual lease payments of $250,000 commencing at the end of this year and there would be no option to purchase or release.

Additionally, if leasing, the firm would have to pay for all maintenance, insurance, and other operating costs just as if it owned the asset, as well as putting up a $75,000 security deposit redeemed when asset is returned to lessor.

The firm's marginal tax bracket is 30%.

Fact Pattern:

Cost of equipment $1,000,000

Depreciation: 5 year Straight Line $180,000 w/salvage value of $100,000

Marginal Tax Rate 30%

Cost of 5 year secure loan 10%/yr (fully amortizing loan)

Annual lease payments $250,000 (at the end of each of the five years)

Lease security deposit $75,000

Expected salvage at year 5 $100,000