The Decision to Lease or Buy at Warf Computers Ltd$.$

Warf Computers Ltd$.$ has decided to proceed with the manufacture and distribution of the virtual keyboard $($VK$)$ the company has

developed. To undertake this venture, the company needs to obtain equipment for the production of the microphone for the

keyboard. Because of the required sensitivity of the microphone and its small size, the company needs specialized equipment for

production.

Nick Warf, the company president, has found a vendor for the equipment. Clapton Acoustical Equipment has offered to sell Warf

Computers the necessary equipment at a price of $$4$ million. Because of the rapid development of new technology, the equipment

falls in CCA class $8$ for depreciation. At the end of four years, the market value of the equipment is expected to be $$480,000.$

Alternatively, the company can lease the equipment from Hendrix Leasing. The lease contract calls for four annual payments of

$$1,040,000,$ due at the beginning of the year. Additionally, Warf Computers must make a security deposit of $$240,000$ that will be

returned when the lease expires. Warf Computers can issue bonds with a yield of $11$ percent, and the company has a marginal tax

rate of $35$ percent.

Should Warf buy or lease the equipment?

Nick mentions to James Hendrix, the president of Hendrix Leasing, that although the company will need the equipment for

four years, he would like a lease contract for two years instead. At the end of the two years, the lease could be renewed. Nick

would also like to eliminate the security deposit, but he would be willing to increase the lease payments to $$1,840,000$ for each

of the two years. When the lease is renewed in two years, Hendrix would consider the increased lease payments in the first two

years when calculating the terms of the renewal. The equipment is expected to have a market value of $$1\mathrm{.}6$ million in two years.

Why might Nick prefer this lease? What are the potential ethical issues concerning the new lease terms?

In the leasing discussion, James informs Nick that the contract could include a purchase option for the equipment at the end of

the lease. Hendrix Leasing offers three purchase options:

a$.$ An option to purchase the equipment at the fair market value.

$b.$ An option to purchase the equipment at a fixed price. The price will be negotiated before the lease is signed.

c$.$ An option to purchase the equipment at a price of $$200,000.$

How would the inclusion of a purchase option affect the value of the lease in each of the above scenarios?