The equipment costs $1,000,000, and, if it were purchased, Lewis could obtain a 4-year term loan with annual year-end payments for the full purchase price at a 10 percent interest rate. Although the equipment has a six-year useful life, it is classified as a special-purpose computer, so it falls into the MACRS 3-year class. If the system were purchased, a 4-year maintenance contract could be obtained at a cost of $20,000 per year, payable at the beginning of each year. The equipment would be sold after 4 years, and the best estimate of its residual value at that time is $200,000. However, since real-time display system technology is changing rapidly, the actual residual value is uncertain.
As an alternative to the borrow-and-buy plan, the equipment manufacturer informed Lewis that Consolidated Leasing would be willing to write a 4-year guideline lease on the equipment, including maintenance, for payments of $260,000 at the beginning of each year. Lewis's marginal federal-plus-state tax rate is 40 percent. You have been asked to analyze the lease-versus-purchase decision, and in the process to answer the following questions:
b. (1) What is the present value cost of owning the equipment? (Hint: Set up a time line which shows the net cash flows over the period t = 0 to t = 4, and then find the PV of these net cash flows, or the PV cost of owning.)
Input Data
New Equipment cost		$1,000
New Equipment life		4
Equip. Residual Value		$200
Tax Rate		40%
Loan interest rate		10%
Annual rental charge		$260
After-tax cost of debt		6%
Maintenance if not leased		$20
Annual Term Loan Payment
	Year =	0	1	2	3	4
Beginning Principal Loan Balance
Interest Payment
Principal Payment
Ending Principal Loan Balance