Management has decided to acquire a new asset that costs $200,000.
The estimated economic life of the asset is five years, but the firm wants
the use of the asset only for three years. If the firm purchases the asset, it
anticipates selling it at the end of three years for $50,000.
The firm may lease the asset for $55,000 a year paid at the end
of each year. The lease does not include maintenance. It is estimated
that annual maintenance initially will be $5,000 (paid at the end of the
year), but that cost will increase by $1,000 each year as the asset ages.
The firm could purchase the asset with a five-year loan of $200,000.
The loan will be retired in five payments of $40,000 unless the equipment
is sold, in which case the loan must be paid off at closing of the
sale. The interest rate is 10 percent and is paid at the end of each year on
the balance owed. The annual interest payment is provided below.
If the firm does purchase the asset, it will enter into a maintenance
agreement with the manufacturer that costs $5,000 a year. The annual depreciation
expense is provided below. The firm's tax bracket is 40 percent.
Based on the above information, should the firm borrow and purchase
or should the firm lease?