Question

You are in the business of raising turkeys for sale to a national grocery store chain. You would like to obtain a new piece of equipment. To buy one would cost $350,000. It would fall in an asset class with an allowable 20% depreciation rate for CCA purposes. There are many other assets in this class. You would keep the equipment for 12 years before it would become obsolete and be worthless.

Instead of buying the equipment, you could lease it. A 12-year lease would involve lease payments of $35,000 per year (due at the beginning of each year).

Your tax rate is 40%. Your farm is financed with 50% debt (from the bank) and 50% equity (your personal investment). Generally, you require a return of 25% on your personal investment to make projects worthwhile. The before-tax cost of debt is 9%.

a) Should you buy or lease the equipment?

b) At what lease payment would you be indifferent between buying or leasing the equipment?

Answer 1

The Machinery should be Leased as the benefit is more in lease