Your boss asks you to review an option to lease an equipment storage facility that the firm needs. You are to compare it with the purchase of the facility. The following information are pertinent to your decision:
a) The facility will be needed for nine years
b) If the facility is leased, the lessor will conduct all maintenance; if purchased, your firm must conduct maintenance
c) Facility maintenance is expected to cost $66000 per year
d) The cost to lease the facility is $400000 per year at the beginning of each year
e) The purchase price of the facility is $5000000 and the market value at the end of nine years is expected to be $4000000
f) The before-tax cost of debt is 7%, and the tax rate is 35%
g) The company's current EBIT is $1750000 (before leasing or purchasing the facility)
Question 1
Assuming that the facility has a nine-year depreciation life for tax purposes (i.e. it can be fully depreciated over nine-years), compute the NPV for each option and based on the cost, indicate your decision (round to nearest $1,000).
A BUY; BUY NPV = -1892000, LEASE NPV = -2285000 B BUY; BUY NPV = -2018000, LEASE NPV = -2159000 C none of them D LEASE; LEASE NPV = -2018000, BUY NPV = -2159000 E LEASE; LEASE NPV = -1892000, BUY NPV = -2285000
Question 2
Assuming that the facility has a seven-year depreciation life for tax purposes (i.e. it will not be fully depreciated by end of nine years), compute the NPV for each option and based on the cost, indicate your decision (round to nearest $1,000).
A LEASE; LEASE NPV = -2018000, BUY NPV = -2099000 B BUY; BUY NPV = -2018000, LEASE NPV = -2099000 C BUY; BUY NPV = -1892000, LEASE NPV = -2225000 D none of them E LEASE; LEASE NPV = -1892000, BUY NPV = -2225000.