Problem: Edison Electronics is considering whether to borrow funds and purchase an asset or to lease the asset under an operating lease arrangement. If it purchases the asset, the cost will be $8,000. It can borrow funds for four years at 12 percent interest. The firm will use the three-year MACRS depreciation category (with the associated four-year write-off). Assume a tax rate of 35 percent.
The other alternative is to sign two operating leases, one with payments of $2,100 for the first two years, and the other with payments of $3,700 for the last two years. In your analysis, round all values to the nearest dollar.
1. Compute the after-tax cost of the leases for the four years.
2. Compute the annual payment for the loan (round to the nearest dollar).
3. Which alternative should be selected, based on minimizing the present value of after -tax costs?