A firm wants to acquire a new machine that has an economic life of 5 years & costs Br. 200,000, delivered & installed. However, the firm plans to lease it for only 4 years. • The machine’s estimated scrap value is Br. 5,000 after 5 years of use, but its estimated residual value, which is the value at the expiration of the lease, is Br. 20,000. Thus, if the firm buys the machine, it would expect to receive Br. 20,000 before taxes when the machine is sold in 4 years. • The firm can borrow the required Br. 200,000 from its bank at a before tax rate of interest of 10%.
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Evaluation of …
• The firm can lease the machine for 4 years at a rental charge of Br 57,000, payable at the beg. of each year. However, the lessor will own the machine at lease expiration. The lease agreement stipulates that the lessor will maintain the machine at no additional charge to the lessee. • However, if the firm borrows & buys the machine, it will have to bear the costs of maintenance, which would be performed by the manufacturer at a fixed contract rate of Br. 2,500 per year, payable at the beg. of each year. • The machine’s depreciation per year is Br. 45,000 & the firm’s tax rate is 40%. Required: Should the firm lease or buy the machine?