Dwyer Corporation Is Determining Whether to Lease or Purchase New

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.

A) The present value of the cash outflow for the lease is $56,151 and for purchasing is $56,775, therefore Dwyer should choose the lease.
B) The present value of the cash outflow for the lease is $56,151 and for purchasing is $56,775, therefore Dwyer should choose purchase.
C) The present value of the cash outflow for the lease is $64,590 and for purchasing is $65,398, therefore Dwyer should choose the lease.
D) The present value of the cash outflow for the lease is $51,178 and for purchasing is $51,703, therefore Dwyer should choose the lease.