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Dwyer Corporation Is Determining Whether to Lease or Purchase New

question 118

Multiple Choice

Dwyer Corporation is determining whether to lease or purchase new equipment. The firm is in the 38% tax bracket, and its after-tax cost of debt is currently 7%. The terms of the lease and the purchase are: Lease: Annual end-of-year lease payments of $31,500 are required over the 3-year life of the lease. All maintenance costs will be paid by the lessor; insurance and other costs will be borne by the lessee. The lessee will exercise its option to purchase the equipment for $6,000 at the termination of the lease.
Purchase: The equipment, costing $77,000, can be financed entirely with a 12% loan requiring annual end-of-year payments of $32,059 for 3 years. The firm will depreciate the equipment under MACRS using a 3-year recovery period (33% in year 1, 45% in year 2, 15% in year 3 and 7% in year 4) . The firm will pay $2,000 per year for a service contract that covers maintenance costs; insurance and other costs will be borne by the firm. The firm plans to keep the equipment and use it beyond its 3-year recovery period.
Calculate the present value of the cash outflow for both the lease and purchasing and recommend one alternative.

Definitions:

Stockholders' Equity

The residual interest in the assets of a corporation that remains after deducting its liabilities, representing ownership interest in the company.

Common Share

A type of equity ownership in a corporation, entitling holders to vote on corporate matters and receive dividends.

Price-Earnings Ratio

A valuation metric for a company, calculated by dividing its current share price by its per-share earnings.

Net Income

The total profit of a business after all expenses, including taxes and operating costs, are subtracted from total revenues.