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Walker Speed-O is considering whether to lease or purchase a piece of research equipment costing $150,000. The firm is in the 40% tax bracket and
Walker Speed-O is considering whether to lease or purchase a piece of research equipment costing $150,000. The firm is in the 40% tax bracket and its after-tax cost of debt is 8%. The terms of each alternative are as follows: Lease: Three-year term with annual end-of-year payments of $59,500. The lessor will pay maintenance costs; Walker-Speed-O will pay for insurance and other costs. It plans to exercise its $25,000 purchase option at the end of the lease term. Purchase: Financed with a three-year, 13% term loan with equal end-of-year payments of $63,530. Interest payments are shown below. The test equipment will be depreciated under ACRS using a 3-year recovery period. The firm will pay $3,500 per year for a maintenance contract and will also cover insurance and other costs. Year Interest 1 $19,500 2 $13,776 3 $7,308 To Do: Parts 1-2 1. Calculate the after-tax cash flows associated with the lease alternative and the after-tax cash flows associated with the purchase alternative. 2. Calculate the present value of the cash flows for both the lease and the purchase alternatives. 3. Which alternative should Walker Speed-O choose? Why
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