A company has decided to acquire a new truck. One alternative is to lease the truck on a 4-year contract for a lease payment of $10,000 per year, with payments to be made at the beginning of each year. The lease would include maintenance. Alternatively, the company could purchase the truck outright for $40,000, financing with a bank loan for the net purchase price, amortized over a 4-year period at an annual interest rate of 10%, payments to be made at the end of each year. Under the borrow-to-purchase arrangement, the company would have to maintain the truck at a cost of $1,000 per year, payable at year-end. The truck falls into the MACRS 3-year class. It has a salvage value of $10,000, which is the expected market value after 4 years, at which time the company plans to replace the truck irrespective of whether it leases or buys. The company has a federal-plus-state tax rate of 40%. [MACRS: 1Y – 33%, 2Y – 45%, 3Y – 15%, 4Y – 7%]
A) What is the company’s PV cost of leasing?
B) What is the company’s PV cost of owning?
C) Should the company purchase or lease? Why?
D) The salvage value is the least certain cash flow in the analysis. How might the company incorporate the higher riskiness of this cash flow into the analysis?