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Dwyer Corporation Is Determining Whether to Lease or Purchase New

question 42

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 leasor; insurance and other costs will be borne by the lessee. The lessee will exercise it option to purchase the equipment for $6000 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 depreciated 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 $2000 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:

Liquidation Expenses

Costs associated with the process of dissolving a company, including paying off debts and distributing remaining assets to shareholders.

Final Settlement

The concluding process in a financial transaction where the seller transfers assets to the buyer, and the buyer pays the seller.

Profit and Loss Sharing

An arrangement, often in partnerships, where profits and losses are distributed among parties based on a pre-agreed ratio.

Final Settlement

The process of completing all financial transactions between parties, often referring to the final payment in a contract or dispute resolution.