Warf Computers 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 Ward, 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 $7.1 million. Because of the rapid development of new technology, the equipment falls in class 45 with a CCA rate of 45%. At the end of four years, the market value of the equipment is expected to be $860,000.

Alternatively, the company can lease the equipment from Hendrix Leasing. The lease contact calls for four annual payments of 1.86 million due at the beginning of the year. Additionally, Warf Computers must make a security deposit of $440,000 that will be returned when the lease expires. Warf Computers can issue bonds with a yield of 11%, and the company has a marginal tax of 35%.

The decision to buy or lease is made by looking at the incremental cash flows. The incremental cash flows from leasing the machine are the security deposits, the lease payments, the tax savings, the lost depreciation tax shield, the saved purchase price of the machine and the lost salvage value.

1. Should Warf buy or lease the equipment?