Wolfson Corporation has decided to purchase a new machine that costs $3 million. The machine will be worthless after three years. Only straight-line method is allowed by the IRS for this type of machine.Wolfson is in the 35-percent tax bracket.
The Sur Bank has offered Wolfson a three-year loan for $3 million.The repayment schedule is three yearly principal repayments of $1 million and an interest charge of 12 percent on the outstanding balance of the loan at the beginning of each year. Twelve percent is the marketwide rate of interest. Both principal repayments and interest are due at the end of each year.
Cal Leasing Corporation offers to lease the same machine to Wolfson. Lease payments of $1.2 million per year are due at the end of each of the three years of the lease.
a. Should Wolfson lease the machine or buy it with bank financing?
b. What is the annual lease payment that will make Wolfson indifferent to whether it leases the machine or purchases it?