The Barnstormer Corp. needs new equipment that would cost $3.5 million and would fall into the MACRS 5-year class for depreciation purposes. Maintenance would be $160,000 per year, payable at the beginning of each year, if they buy the equipment themselves. They could borrow at a 9% rate of interest, before tax, if they were to buy the equipment directly. They plan on using the equipment for 5 years before it will need to be replaced with something more modern. The estimated residual value of the equipment in five years is $750,000.
Barnstormer has found a leasing company that would be willing to lease the equipment to them for 5 years for $570,000 per year, payable at the beginning of the year. Maintenance would be included in the lease payment. Barnstormer is in the 30% marginal tax bracket.
1. Should Barnstormer lease the equipment or buy the equipment? Explain.
2. What is the NPV of the lease to the leasing company if they have a borrowing rate of 6% and a tax rate of 45%?