Janet Wigandt, an electrical engineer for Instrument Control, Inc. (ICI), has been asked to perform a lease–buy analysis of a new pin inserting machine for ICI’s PC board manufacturing.
• Buy Option. The equipment costs $120,000. To purchase it, ICI could obtain a term loan for the full amount at 10% interest, payable in four equal end of year annual installments. The machine falls into a five year MACRS property classification.
· Annual revenues of $200,000 and operating costs of $40,000 are anticipated. The machine requires annual maintenance at a cost of $10,000. Because technology is changing rapidly in pin inserting machinery, the salvage value of the machine is expected to be only $20,000.
• Lease Option. Business Leasing, Inc. (BLI), is willing to write a four year operating lease on the equipment for payments of $44,000 at the beginning of each year. Under this arrangement, BLI will maintain the asset, so that the annual maintenance cost of $10,000 will be saved. ICI’s marginal tax rate is 40%, and its MARR is 15% during the analysis period.
(a) What is ICI’s present value (incremental) cost of owning the equipment?
(b) What is ICI’s present value (incremental) cost of leasing the equipment?
(c) Should ICI buy or lease the equipment?