What is the free cash flow from buying

Reference no: EM133290960

Question: A firm is considering purchasing a new equipment for $20million. If it purchases the equipment, it will depreciate on a straight-line basis over the five years, after which the equipment will be worthless. The firm will also be responsible for maintenance expenses of $2 million per year. Alternatively, it can lease the equipment for $4.3 million per year for the five years, in which case the lessor will provide necessary maintenance. The firm's tax rate is 40% and its borrowing cost is 7.5%.

a. What is the free cash flow (FCF) from buying?

b. What is the free cash flow (FCF) from leasing?

c. Which option is better? Justify using the NPV approach.

d. Under certain conditions, both the lessee and lessor have incentives to establish a lease contract. Explain those conditions.

Reference no: EM133290960

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