Reference no: EM132905042

Urgent !

(a) What are the key differences between leasing and borrowing? Are they perfect substitutes?

(b) Techno Company needs to expand its facilities. To do so, the firm must acquire a machine costing $80,000. The machine can be leased or purchased. The firm is in the 40 percent tax bracket, and its after tax cost of debt is 9 percent. The terms of the lease and purchase plans are as follows: Lease - The leasing arrangement requires end-of-year payments of $19,800 over 5 years. All maintenance costs will be paid by the lessor; insurance and other costs will be borne by the lessee. The lessee will exercise its option to purchase the asset for $24,000 at termination of the lease. Purchase - If the firm purchases the machine, its cost of $80,000 will be financed with a 5-year, 14 percent loan requiring end-of-year payments of $23,302. The machine will be depreciated using the straight line method over 5 years.

The firm pay $2,000 per year for a service contract that covers all maintenance costs; insurance and other costs will be borne by the firm. The firm plans to keep the machine and use it beyond its 5-year recovery period.

Required:

(i) Determine the net after-tax cash flows of the leasing versus purchase alternatives.

(ii) Calculate the net advantage of leasing over purchase. Should the company lease the machine?