Fly Away Corporation makes pumps for the aviation industry. They are contemplating buying a new machine that costs $25,000. Arrangements can be made to lease or purchase the machine. The firm is in the 40% tax bracket. Lease: If they lease, the firm would obtain a 5-year lease requiring annual end-of-year lease payments of $5,000. All maintenance costs would be paid by the lessor. The lessee would exercise its option to purchase the machine for $1,200 at termination of the lease. Purchase: The firm would finance the purchase of the machine with a 7%, 5-year loan requiring end-of-year installment payments of $6,097. The machine would be depreciated under MACRS using a 5-year recovery period (20% in year 1, 32% in year 2, 19% in year 3, 12% in years 4 and 5). The firm would pay $1,500 per year for a service contract that covers all maintenance costs; insurance and other costs would be borne by the firm. The firm plans to keep the machine and use it beyond its 5-year recover period. The interest payments and depreciation provide a tax shield to the owner.
Determine if Fly Away Corporation should lease or purchase the machine and why. You can use an Excel spreadsheet or calculator to help. Make sure that whatever you use, you keep track of *all your work and turn that in with your answer. Providing all of your work will make it easier to explain your answer. *Be sure to discount cash flows at a 6% discount rate.