Question 3

A company has decided to replace an existing machine with a new one that can either be purchased for $70,000 or leased for $20,000 per year (due at the beginning of each year). The old machine has a book value of $20,000 and can be sold for $5,000. The new machine has an expected useful life of five years and an expected salvage value of $8,000. The new machine will require an overhaul at the end of the third year at an estimated cost of $10,000, which is tax deductible. The company's cost of debt is 8%, WACC is 12%, and marginal tax rate is 40%. The machine has a CCA rate of 30%.

(a) Should the company lease or buy the machine?

(b) If the overhaul is paid by the lessor, should the company lease or buy the machine?