Problem: You have the option of leasing an asset for $100,000 per year, with payments to be made at the end of each year of use. This lease cannot be cancelled. Alternatively, you may buy the asset for $248,700. For reimbursement purposes, the lease must be capitalized. If the asset is purchased, it will be debt-financed with $210,000 of three-year serial notes (that is, $70,000 of principal will be repaid each year). The effective interest rate on this loan will be eight percent. Assume that the asset has an allowable useful life of three years with no estimated salvage value.
Q1. Determine the amount of expense that would be reported during each of the three years under the two financing plans.
Q2. Assuming that 80 percent of all reported capital expenses are reimbursed and that the discount rate is six percent, determine the present value of the asset in these two methods of financing.