Guatemalan Corp. (GC) is trying to decide whether to lease or buy a new computer-assisted manufacturing system from Spain. Management has decided that it must use the system to remain competitive against foreign competitors. The system costs 60 million EUR and will be depreciated straight-line to zero over five years. GC’s effective tax rate is 30%, and the firm can borrow at 8%. Finn Leasing Company (FLC) has offered to lease the system to GC for over a five-year period with payments of 14 million EUR per year. FLC’s policy is to require its lessees to make payments at the start of the year.
a) What is the NPV of the lease for GC?
b) What is the maximum lease payment that would be acceptable for GC?
c) Suppose that the equipment is estimated to have a residual value of 5 million EUR at the end of the lease. Management feels that the higher degree of uncertainty for this cash flow justifies a 10% after-tax discount rate. What is the maximum lease payment acceptable to GC now?
d) In addition to the new assumption in part (c), suppose that FLC requires GC to pay 5 million EUR security deposit at the start of the lease that will be fully recovered at the end of the lease’s life. If the lease payment is still 14 million EUR, is it still advantageous for GC to lease the equipment?