Vector Insight Corp.'s (VIC) management needs a new Vectometer and has a decision to make. The company historically has purchased its Vectometers, the machine used to manufacture Vecs. I-Vec, Inc., the manufacturer of Vectometers is offering VIC the opportunity purchase or lease its new Vectometer as it prefers. If it leases the equipment, the lease term is five years at a cost of $800,000 annually payable in advance, and the annual maintenance expenses payable at the end of the first four years are estimated to be $75,300. VIC would have to pay sales tax of 6.75% on each lease payment. Both the lease payment and the sales taxes are deductible for income tax purposes. Alternatively, VIC can purchase the Vectometer for $4,000,000. The equipment is considered 3-year MACRS property, but has a useful life of 6 years. Annual maintenance expenses, payable at the end of the first five years of operations are expected to be $65,500 if the equipment is purchased. Vic typically uses Vectometers for the full useful life and salvages them for 15.0% of their purchase price. Under either alternative, VIC's corporate tax rate is 22.0%, and its cost of capital is 10.0% Required: a. What is the equivalent annual cost of buying and maintaining the Vectometer? b. Which is the better option: leasing or buying? Why? c. Which is the better option if the cost of capital is 14.0%. d. Why might maintenance costs for the leased Vectometer exceed the maintenance costs of the purchased Vectometer? Vector Insight Corp.'s (VIC) management needs a new Vectometer and has a decision to make. The company historically has purchased its Vectometers, the machine used to manufacture Vecs. I-Vec, Inc., the manufacturer of Vectometers is offering VIC the opportunity purchase or lease its new Vectometer as it prefers. If it leases the equipment, the lease term is five years at a cost of $800,000 annually payable in advance, and the annual maintenance expenses payable at the end of the first four years are estimated to be $75,300. VIC would have to pay sales tax of 6.75% on each lease payment. Both the lease payment and the sales taxes are deductible for income tax purposes. Alternatively, VIC can purchase the Vectometer for $4,000,000. The equipment is considered 3-year MACRS property, but has a useful life of 6 years. Annual maintenance expenses, payable at the end of the first five years of operations are expected to be $65,500 if the equipment is purchased. Vic typically uses Vectometers for the full useful life and salvages them for 15.0% of their purchase price. Under either alternative, VIC's corporate tax rate is 22.0%, and its cost of capital is 10.0% Required: a. What is the equivalent annual cost of buying and maintaining the Vectometer? b. Which is the better option: leasing or buying? Why? c. Which is the better option if the cost of capital is 14.0%. d. Why might maintenance costs for the leased Vectometer exceed the maintenance costs of the purchased Vectometer
