Your company “Digitup Ltd” needs a new earth moving machine which it can buy for USD150,000. The economic life of the machine is 8 years. It can lease the machine for 8 years, with lease payments due at the start of each year. Your cost of borrowing to buy the digger is 12% and your tax rate is 26%. Your maintenance and insurance costs are estimated to be $18,000 per annum.
The local Caterpillar agent can buy the digger from CAT for $80,000 and deprecate this over 7 years on a straight line basis. Its cost of borrowing is 7% with an overall tax rate of 32%. The agent will incur maintenance and insurance costs of $10,000 per annum.
What is the net tax adjusted annual cost of borrowing and maintenance incurred by Digitup if it borrows to buy the machine?
If the local CAT leasing company wishes to make a 10% mar- up on the before tax break-even leasing costs what will it charge Digitup to lease the digger? What would you advise the company to do and why?
Show all your calculations
Are markets efficient or random? What lessons have you learned from the theory of behavioural finance? (500 words)