Lease versus buy
Morris-Meyer Mining Company must install $1.5 million of new machinery in its Nevada mine. It can obtain a bank loan for 100% of the required amount. Alternatively, a Nevada investment banking from that represents a group of investors believes that it can arrange for a lease financing plan. Assume that the following facts apply:
The equipment falls in the MACRS 3-year class. The applicable MACRS rates are 32%, 44%, 15%, and 7%.
Estimated maintenance expenses are $65,000 per year.
Morris-Meyer's federal-plus-state tax rate is 40%.
If the money is borrowed, the bank loan will be at a rate of 18%, amortized in 4 equal installments to be paid at the end of each year.
The tentative lease terms call for end-of-year payments of $300,000 per year for 4 year.
Under the proposed lease terms, the lessee must pay for insurance, property taxes, and maintenance.
The equipment has an estimated salvage value of $300,000, which is the expected market value after 4 years, at which time Morris-Meyer plans to replace the equipment regardless of whether the firm leases or purchases it. The best estimate for the salvage value is $300,000, but it may be much higher or lower under certain circumstances.
To assist management in marking the proper lease-versus-buy decision, you are asked to answer the following questions.
Assuming that the lease can be arranged, should Morris-Meyer lease or borrow and buy the equipment? Explain. Round your answer to the whole number.
Net advantage to leasing (NAL) is $ . (Input the minus sign if the cost of leasing the machinery is more than the cost of owning it.)
Morris-Meyer should -Select-leaseborrowItem 2 the equipment.
Consider the $300,000 estimated salvage value. Is it appropriate to discount it at the same rate as the other cash flows? What about the other cash flows - are they all equally risky?
We discounted it at the same rate, but it -Select-is moreis lessItem 3 risky, so we should use a -Select-higherlowerItem 4 discount rate. By doing so, you -Select-reduceincreaseItem 5 the value of the inflow in the last year in the cost of owning analysis.
Explain.
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