Question

Alpha Point Ltd. needs an engineering system that costs $40,000. The company either can lease the equipment or borrow $40,000 from a local bank and buy the system. The company's tax rate is 40% and that the system's CCA would be $20,000 per year. If the company leased the system on a 2-year lease, the payment would be $22,000 at the beginning of each year. If the company borrowed and bought, the bank would charge 10% interest on the loan. In either case, the system's salvage value is zero. Should the company buy or lease the system?

Answer 1

Ans Lets evaluate both the options of Buy vs Lease Option Buy Option Lease Year Year 0 0 1 2 Cost of Buying CCA Interst Tax Benefit Net Cash Flow (40,000) (40,000) (20,000) (4,000) 9,600 (14,400) (20,000) (4,000) 9,600 (14,400) Lease Tax Benefit Net Cash Flow (22,000) 8,800 (30,800) (22,000) 8,800 (30,800) 2 Note :lease is paid at the beginning of the period Note: Salvage value is 0 Interest Rate on Bank Loan is 10% Present value of Total outlfow Formual NPV(10%. Net Cash Flow 1:2)+net Cash flow (64,992) (58,800) Present value under the lease option is less, so company should lease the system, it will be less expenstive.