Please explain why the following should be leased or purchased: Purchasing Costs
ID: 2673773 • Letter: P
Question
Please explain why the following should be leased or purchased:
Purchasing Costs:
-Product A has an invoice price of $250,000 (includes delievery and installation)
-Money can be borrowed with a four year amortized loan, with a 10% interest rate
-Loan would be paid at the end of each year
-If product purchases, it will be contracted and serviced for a fee of $20,000 per year at the end of each year
-The product will depreciate over four years (straight line method), with a salvage value of $42,500
-The company's tax rate is 40%
Versus Leasing:
-Product A will be leased at $70,000 upon delievery & installation (at t=0); there will be an extra 4 lease payments of $70,000 to be made at the end of the years 1-4
-Regardless if leased or purchased, the company has no plans to keep product A more then 4 years
Explanation / Answer
Comparing the two options, the better option would be to purchase. If you amortize the principal, it will be aproximately $74,000 over four years, about $300,000. The service is $20,000, adding this to the total and you have approximately $380,000 a year. Comparing this to the lease, you have to pay $70,000 at the start, plus $70,000 at the end of years one through four giving a total of ~$500,000. It is clearly better to purchase in the long-run. The tax difference is not enough to account for the over $100,000 one would be saving.