A firm has decided to acquire as asset costing 150000 that h

A firm has decided to acquire as asset costing $150,000 that has an expected life 3 years. Straight line depreciation method is to be applied without residual value. The asset can be purchsed by borrowing or it can be leased. If leasing is used, the lessor requires 10% return, where payment to be made semi-annually at the beginning of each period. If loan, the cost of borrowing is 8% and the loan will be paid semi-annually.

If tax rate is 40% which alternative (lease or purchase) would you recommend?

Solution

Leased amount Residual Value Annual Interest Rate Term

150000 0 10%(Compounded Once a year) 6 Periods(2 payments per year)

  If Lease option is preferred,the following is the repayment schedule:

Loan amount Annual Interest Rate Term

150000 8%(Compounded Once a year) 6 Periods(2 payments per year)

If Loan option is preferred the following is the repayment schedule:

Lease option Outflows : $29,440.14 * 6 = $176640.84

Loan option Outflows : $28,542.64 * 6 = $171255.84

As Outflows from loan option is less,Borrowing a loan is suggested.