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QUESTION - Braxton Enterprises is evaluating a project which involves producing a new drug. The project requires an investment in a new plant. Braxton Enterprises can either borrow the money to buy the plant or lease the plant from its manufacturer. The details of each alternative are shown as follows:
Purchase: The purchase price of the plant is $800,000 and is expected to have a salvage value of $50,000 at the end of its 4-year life. The plant qualifies for 25% reducing balance depreciation if owned.
Lease: The lease involves four annual payments in arears of $150,000 payable at the end of each year, and a residual payment of $30,000 payable at the end of the lease term, i.e., at the end of year 4.
The company tax rate is 30%. The borrowing rate is 8% per annum. Calculate the NPV of leasing and advise the company as to whether it should purchase or lease the plant.
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