Practice Problem 2: Each step matters

Jamma Corporation is interested in a piece of equipment required to build an addition onto their new building, which costs $500,000 and has a five-year useful life.For capital budgeting purposes the before-tax cash flows are estimated to be $185,000 per year (including maintenance costs); the firm's marginal tax rate is 40% and the cost of capital is 16%.The equipment is in a class with a CCA rate of 30%; the lease rate is $90,000 at the beginning of each year for five years and the before-tax cost of borrowing is 14%.If the equipment is purchased, Jamma Corp will have annual maintenance costs of $12,000.Under the lease agreement, the lessee will provide regular maintenance.In addition, the lessor requires additional insurance coverage that will be the responsibility of the lessee.The annual cost of this insurance will be $15,000. The expected salvage value at the end of 5 years is $120,000. Based on NPV analysis, the firm has determined that the project should be accepted.Should the equipment should be leased or purchased?

Write out in words what each step involves and its logic, analysis and caluclations (to 3 decimal places) answer for each step. Show all you work. Finish with the NPV of the lease analysis.( this means explain the logic and analytical value of a lease analysis) State clearly your final recommendation for Jamma Corporation and explain why that is their best course of action to take.