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Question - Machine Tool Ltd needs to acquire a machine to set up its factory in a backward region costing $1,000,000. The machine is expected to have an economic useful life of 5 years.
The company is considering the alternative choices of:
i. Purchasing the asset outright by raising a loan or
ii. Taking the machinery on lease
The company can raise debt at 14% payable in 5 equal annual installments, each installment due at the beginning of the year. In contrast, leasing payments are to be made in advance and the lessor requires the asset to be completely amortized over its useful period; the asset will yield him a return of 5%. It is expected that the operative costs would remain the same under either method. The machine is subject to straight line method of depreciation to a zero salvage value at the end of useful life. The company is in the 50% tax bracket. Should it lease or buy the machine?
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