Question

# Your firm has just sold non-strategic assets to raise cash for capital investment while avoiding the...

Your firm has just sold non-strategic assets to raise cash for capital investment while avoiding the use of debt. The firm may buy a piece of machinery for \$140,000 [with a useful or depreciable life of 4 years]. Your pretax cost of capital is 8% [and your tax rate is 20%]. You can lease the machine for \$43,500 per year and the estimated salvage/recovery value at the end of four years [based on actual market data] is \$20,000. Should you lease or buy? Explain by showing your work.

Cash outflow in Buying Machinery Initially = \$140,000

Depreciation on Machinery per year = (\$ 140,000 - \$20,000 )/4 = \$30,000

Tax Saving @20% on Depreciation each year = \$30,000*20 = \$6,000

Present value of Tax Saving = \$1400 * pv factor of 8% for (1-4years) - \$6000 * 3.312 =\$19872

Present value of Salavage value of machine = \$20,000* Pv factor of 8% for year 4 = \$20,000*0.735 = \$14700

Cash Outflow = \$ 140,000 - (\$ 19872 + \$14,700) = \$1,05,428

ON LEASE OF MACHINE

Lease rent to Pay each year upto 4 year = \$43,500

Pv factor at 8% for 1 to 4 year = 3.312

Present value of Lease rent payable = \$43,500*3.312 = \$144,072

Cash Out flow on LEASE = \$144,072

Conclusion ;- BUY option should be choose.