As a financial analyst for Muffin Construction, you have been asked to recommend the method of financing the acquisition of new equipment needed by the firm.
The equipment has a useful life of eight years. If purchased, the equipment, which costs $700,000, will be depreciated under MACRS rules for 7-year class assets. If purchased, the needed funds can be borrowed at a 10 percent pretax annual rate.
Muffin's weighted after-tax rate of capital is 12 percent. The actual salvage value at the end of eight years is expected to be $50,000. Muffin's marginal ordinary tax rate is 40 percent. Annual, beginning-of-year lease payments would be $160,000.
a. Compute the net advantage to leasing.
b. Should Muffin lease or own the equipment?