Question 4a
Spot Co is considering how to finance the acquisition of a machine costing $750,000 with an operating life of five years. There are two financing options.
Option 1
The machine could be leased for an annual lease payment of $155,000 per year, payable at the start of each year.
Option 2
The machine could be bought for $750,000 using a bank loan charging interest at an annual rate of 7% per year.
At the end of five years, the machine would have a scrap value of 10% of the purchase price. If the machine is bought, maintenance costs of $20,000 per year would be incurred.
Taxation must be ignored.
Required:
Evaluate whether Spot Co should use leasing or borrowing as a source of finance, explaining the evaluation method which you use. (10 marks)