You are considering the acquisition of equipment valued at $1,000,000. You have the option to purchase it with cash outright with a single payment at the time of purchase. Additionally, you plan to obtain a comprehensive maintenance plan from the manufacturer, costing $20,000 annually, payable at the beginning of each year, covering all maintenance expenses. Your company's weighted average cost of capital (WACC) is 6%, and you perceive the project's risk to align with your firm's overall risk level.

Your intention is to sell the asset after four years, anticipating a scrap value of $100,000, although this resale price carries substantial uncertainty. Initially, we assume that the scrap value is discounted at the same rate as other assets, although this assumption may change later.

Alternatively, you have the option to lease the equipment. A lessor offers you an annual lease cost of $275,000, with payments made at the beginning of each year. The lessor will assume responsibility for all maintenance costs, and they will also purchase a maintenance plan from the manufacturer at a cost of $20,000 per year. The lessor is more adept at reselling used assets and expects a scrap value of $260,000. Their cost of capital is 4.8%.

Both you and the lessor are subject to a 21% corporate income tax rate, but addressing this matter is a concern for another day.

Extensions:

1. Can you negotiate a lower lease price?

a. If negotiation is possible, what is the lowest conceivable price you could attain?

b. What is the highest conceivable lease price the lessor could expect?

c. What factors might shift bargaining power in favor of the lessor or lessee? Provide one example of each.

2. How would the answer change if you used a 4-year straight-line depreciation method instead of the MACRS schedule? This approach is more common among non-profit institutions.

3. How would the answer change if the equipment had a seven-year depreciation schedule?

4. Your finance expert suggests that the scrap value is riskier than other cash flows and should be discounted at a rate 3 percentage points higher than your cost of capital. The same adjustment applies to the lessor. How does this impact the Net Advantage of Leasing (NAL) and the Lessor's Net Present Value (NPV)?

5. The manufacturer has introduced a new sales option where maintenance contract payments are made at the end of the year. How does this alter the cost of ownership, leasing, and the lessor's NPV?

6. What happens to the NAL if you borrow money and amortize the equipment purchase price of $1,000,000? You are offered a 4-year loan at 3% interest, requiring a 20% down payment at the time of purchase. Principal and interest payments are made annually at the end of the year. The lower loan interest rate is due to the vendor's ability to repossess the equipment in case of default. Additionally, a 6% sales tax is applicable to both the lease payment and the capital equipment purchase price, with the buyer responsible for paying the sales tax.

7. Based on the results from your base model and model 5, what would be the ownership and leasing costs for a non-profit health system with a tax rate of 0%?