QUESTION 1 [50%]

MWIBROS Construction Company has conducted an investment appraisal on a four-year project and has decided to proceed with the investment. The project involves the acquisition of plant and machinery that could be purchased for $280,000. The assets are expected to have a negligible residual value at the end of the project.

Alternatively, the assets could be leased using a finance lease for $85,000 a year, payable in advance. Under such an arrangement the lessee would be responsible for all maintenance costs during the term of the lease. After the lease period expires, ownership of the assets would pass to MWIBROS Construction Company. The implied interest and straight-line accounting depreciation will be tax allowable.

The company is subject to tax at 22 %, payable one year in arrears. Tax depreciation allowances are available to the purchaser of business assets at 40 per cent a year on a reducing-balance basis. The company is able to borrow at an annual interest rate of 9 per cent.

1. You are required to determine whether it would be cheaper for the company to lease the assets or to buy them.
2. Determine the type of lease and how it is treated in the books of accounts.