Use the Following Information to Answer the Question(s) Below

question 23

Multiple Choice

Use the following information to answer the question(s) below.
Rearden Metal is considering the purchase of a new blast furnace costing a total of $5 million dollars. This furnace will qualify for accelerated depreciation: 20% can be expense immediately, followed by 32%, 19.2%, 11.52%, 11.52% and 5.76% over the next five years. However, because of Rearden's substantial tax loss carry forwards, Rearden estimates its marginal tax rate to be only 10% over the next five years. Since Rearden will get very little tax benefit from the depreciation expense, they consider leasing the furnace instead. Suppose that Rearden and the lessor face the same 8% borrowing rate, but the lessor has a 40% marginal tax rate. Assume that the furnace is worthless after five years, the lease term is five years, and a lease would qualify as a true tax lease.
-Assuming that Rearden's annual lease payments are $1.1 million,then Rearden Metal should

• A) lease the furnace since the amount saved in year zero from leasing is greater than the amount of the lease equivalent loan.
• B) buy the furnace since the amount saved in year zero from leasing is greater than the amount of the lease equivalent loan.
• C) lease the furnace since the amount saved in year zero from leasing is less than the amount of the lease equivalent loan.
• D) buy the furnace since the amount saved in year zero from leasing is less than the amount of the lease equivalent loan.
• E) Rearden will be indifferent between buying and leasing since the amount saved in year zero from leasing equals the amount of the lease equivalent loan.

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