Question 1: (Net advantage to leasing) Allied Metals, Inc., is considering leasing $1 million worth of manufacturing equipment under a lease that would require annual lease payments in arrears for five years. The net cash flows to lessee over the term of the lease (with zero residual value) are given here. Allied's cost of secured debt is 12%, and its cost of capital is 16%.
Allied pays taxes at a 34% marginal rate.
a. Calculate the net advantage to leasing.
b. Should Allied lease, or borrow and buy?
Year 0 1 2 3 4 5
Net cash flow ($000) 1,000 -300 -275 -250 -225 -200