Reference no: EM132659134

Lease versus buy

Morris-Meyer Mining Company must install $1.3 million of new machinery in its Nevada mine. It can obtain a bank loan for 100% of the required amount. Alternatively, a Nevada investment banking from that represents a group of investors believes that it can arrange for a lease financing plan.

Assume that the following facts apply:

1. The equipment falls in the MACRS 3-year class. The applicable MACRS rates are 33%, 45%, 15%, and 7%.
2. Estimated maintenance expenses are $65,000 per year.
3. Morris-Meyer's federal-plus-state tax rate is 30%.
4. If the money is borrowed, the bank loan will be at a rate of 16%, amortized in 4 equal installments to be paid at the end of each year.
5. The tentative lease terms call for end-of-year payments of $300,000 per year for 4 year.
6. Under the proposed lease terms, the lessee must pay for insurance, property taxes, and maintenance.
7. The equipment has an estimated salvage value of $300,000, which is the expected market value after 4 years, at which time Morris-Meyer plans to replace the equipment regardless of whether the firm leases or purchases it. The best estimate for the salvage value is $300,000, but it may be much higher or lower under certain circumstances.

To assist management in marking the proper lease-versus-buy decision, you are asked to answer the following questions.

Question 1: Assuming that the lease can be arranged, should Morris-Meyer lease or borrow and buy the equipment? Explain. Round your answer to the whole number.

Question 2: Net advantage to leasing (NAL) is $ . (Input the minus sign if the cost of leasing the machinery is more than the cost of owning it.)