I2C Beams Ltd., a manufacturer of lighted hockey pucks, is negotiating with the Hat Trick Company to purchase or to lease a machine that produces red-lighted pucks. The machine would cost $140,000. In five years the machine would have an estimated salvage value of $35,000. Its useful economic life is nine years.

I2C Beams can borrow funds at 9 percent from its Playoff Bank and has a tax rate of 25 percent. The capital cost rate on this machine is 30 percent, and I2C Beam’s cost of capital is 14 percent. Lease payments would be at the beginning of each year, and tax savings would occur at the end of each year. Lease payments would be $29,000 over a five-year term.

We note that of all the cash flows, the salvage value has the greatest uncertainty. We recognize this by discounting the salvage value at a higher discount rate—the cost of capital.

a-1. Calculate PV cost of lease alternative. (Do not round the intermediate calculations. Round the final answer to nearest whole dollar. Input the answer as positive value.)

PV cost $

a-2. Calculate PV cost of borrowing/purchase alternative. (Do not round the intermediate calculations. Round the final answer to nearest whole dollar. Input the answer as positive value.)

PV cost $

b. Should I2C Beams Ltd. lease or borrow to purchase the machine?

multiple choice

Lease

Borrow/Purchase