Lease and buy decision making using present value technique

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Reference no: EM1312918

Lease and Buy decision making using present value technique

Biomedical Labs, Inc. is considering whether to lease or purchase a piece of research equipment costing $150,000. The firm is in the 40% tax bracket and its after-tax cost of debt is 8%. The terms of each alternative are as follows:

Lease: Three-year term with annual end-of-year payments of $59,500. The lessor will pay maintenance costs; Biomedical Labs will pay for insurance and other costs. It plans to exercise its $25,000 purchase option at the end of the lease term.

Purchase: Financed with a three-year, 13% term loan with equal end-of-year payments of $63,530. Interest payments are shown below. The test equipment will be depreciated under ACRS using a three-year recovery period. The firm will pay $3,500 per year for a maintenance contract and will also cover insurance and other costs.

Year Interest
1 $19,500
2 13,776
3 7,308

(a) Calculate the after-tax cash flows associated with the lease alternative and the after-tax cash flows associated with the purchase alternative.

(b) Calculate the present value of the cash flows for both the lease and the purchase alternatives.

Reference no: EM1312918

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