QFIN Limited must replace some of its equipment with new stainless steel equipment. The controller is unsure whether to purchase the equipment with borrowed money or to lease the equipment. If purchased, the equipment will cost HK$800,000 and have an estimated useful life of 16 years and no residual value. HSBC is willing to provide the HK$800,000 to QFIN. The loan terms are that the 10-year note would bear interest at 8% per year. QFIN would be required to pay the interest annually at the end of each year. The principal amount would be due at the end of the 10 years. A local rental company is willing to lease the equipment to QFIN for 12 years at an interest rate of 7% per year. At the end of each year, QFIN would be required to pay the leasing company HK$96,000. At the end of the lease period, title to the equipment would remain with the lesser.
Required:
(1) Calculate the present value of the future cash flows under both arrangements.
(2) State what amounts would appear in QFIN's income statement and balance sheet for the first year, under both alternatives. Assume the new equipment arrive on 1 January 2010.
(3) Which of the two financing alternatives would you recommend to the controller? Why? What factors, other than cash payments directly related to financing, might be important to the decision?