Lolita Company willing to buy a fabric machine for $100,000. The equipment is planned to be utilized for 8 years, after which it will have a residual worth of $20,000. Lolita would need to sign an 8-year "true" lease contract to finance the cutting machine equipment, which would entail annual lease payments of $16,000 (payable in advance).
The corporation might alternatively finance the machine's acquisition with a 12 % term loan with the same payment schedule as the lease. The asset falls in the 5-year property class for cost recovery (depreciation) purposes, and the company has a 35% tax rate. What is the present value of cash outflows for each of these alternatives, using the after-tax cost of debt as the discount rate? Which alternative is preferred ?
[ prepare the table of cash flow, debt payment in detail]
