Q.No. 3 (6 marks)

You are hired as an analyst for Engro Corporation. During your first assignment, you are asked to perform a buy versus lease analysis on a newly developed machine. The machine cost Rs. 1,200,000 and if Engro decide to purchase it, a term loan can be obtained at a cost of 10%. The amount of the loan will be amortized in 4-year machine life (with the payments made at the end of each year). This is the special purpose machine and falls into MACRS 3-year class for depreciation purpose. The depreciation rates for this machine are 33%,45%,15%, and 7% for the next four years, respectively. The purchase of the machine will result in a maintenance cost of Rs. 25,000 payables at the beginning of each year. The residual salvage value of the machine is estimated to be Rs. 125,000 after its useful life of 4-years.

Because of rapid changes in technology and uncertainty around residual value, a useful alternate is to arrange this machine through leasing. Orix leasing company has shown interest to give the machine at a 4-year lease, including its maintenance, for a total payment of Rs. 340,000 at the beginning of each year. Engros federal tax rate is 40%. The management has asked you to help by answering the following questions.

a. Calculate the Engros present value cost of owning the machine (Hint: Calculate the present value of all the cashflows from year 0 to year 4). Explain the logic for the discount rate you used to find the PV (3 marks)

b. What is Engros present value cost of leasing the Machine? (Hint: Again, repeat what you did in case of owning the machine in part a). Is there any net advantage to leasing? Should Engro buy or lease the Machine? Explain (3 marks)