Your company Digitup Ltd needs a new earth moving machine which it can buy for GBP 120,000. The economic life of the machine is 6 years. It can lease the machine for 6 years, with lease payments due at the start of each year, or buy it outright. Hello Yellow Ltd is a leasing company specialising in construction equipment. Due to its volume trades with the supplier it can get a superior discount and buy the machine for GBP 100,000 and depreciate it over 5 years to zero terminal value with maintenance and administration costs of an estimated 12,000 p.a.. Inflation is zero, Hello Yellows cost of capital is 7% and has an average tax rate of 28%. What is the break-even lease that the company will charge if it lease for 6 years with payment annually in advance?

Is this lease attractive to Digitup if its cost of capital is 8% and its tax rate is 35%? It will borrow to buy at its cost of capital and amortise the loan fully over 6 years depreciating the asset over that period on a straight-line basis.