Reference no: EM132016383
DogChew Products needs to replace its rawhide tanning and molding equipment. They have undergone a capital budgeting NPV analysis and have determined they should accept the project. You have been provided with the following information
The equipment has a purchase price of $930,000 and has a seven-year useful life.
The estimated salvage value is $95,000 in seven years.
If they lease the equipment from RayNot Financing, the lease payments will be $205,000 per year for 7 years with the payments made at the beginning of the year.
If the asset is purchased, Dog Chew Products will be responsible for maintenance costs of $55,000 per year; if leased, the lessee will be responsible for maintenance costs. Maintenance costs are paid at the end of the year.
If the asset is leased, additional insurance of $10,000 per year will be required which the lessee is responsible for. This must be paid at the beginning of each year.
The asset belongs in an asset class with a CCA rate of 20%.
Dog Chew Products has a marginal tax rate of 35%. The before-tax cost of debt is 9%. The lease qualifies as a true tax lease for tax purposes.
Should Dog Chew Products buy or lease the equipment? Prepare a NPV Lease analysis.
How would your answer to part (a) change if the lessor was responsible for the annual maintenance costs? Show your work.