Walton Publishing Company WPC is evaluating a potential leas

Walton Publishing Company (WPC) is evaluating a potential lease agreement on a printing press that costs $250,000 and falls into the MACRS 3-year class. The firm can borrow at an 8 percent rate on a 4-year amortized loan, if WPC decides to borrow and buy rather than lease. The press has a 4-year economic life, and its estimated residual value is $25,000 at the end of year 4. If WPC buys the press, it would purchase a maintenance contract that costs $5,000 per year, payable at the beginning of each year. The lease terms which include maintenance call for a $71,000 lease payment at the beginning of each year. WPC\'s tax rate is 40 percent. Should the firm lease or buy?

Solution

Look below the following tables for details

YEAR 0 1 2 3 4
Buy
Loan -250,000.00
depreciation -82,500.00 -112,500.00 -37,500.00 -17,500.00
tax savings 33,000.00 45,000.00 15,000.00 7,000.00
at maintenance-5,000.0-5,000.00 -5,000.00 -5,000.00 0.00
residual value 25,000.00
free cash flow buy -250,000.00 ,28,000.00, 40,000.00, 10,000.00, 32,000.00
PV(loan)-255,000.00 26,717.56 36,419.79 8,687.93 26,528.02 -156,646.71
After tax borrowing =.6*.08=4.8%

Lease payments 71,000.00 71,000.00 71,000.00 71,000.00
tax savings -28,400.00 -28,400.00 -28,400.00 -28,400.00 0.00
cash flow lease 42,600.00 42,600.00 42,600.00 42,600.0 0.00
PV(lease) 42,600.00 40,648.85 38,787.08 37,010.57 0.00
159,046.50 (lease)
156.646.71 (buy)
lease vs. loan 2,399.79
So the PV for lease is higher than pv for loan. Hence they should opt out for Leasing the machine rather than taking a loan to buy it