Morris-Myer mining Company must install $1.5 million of new equipment in its Nevada mine. It can obtain a bank loan for the entire amount required. Alternatively, its financial advisors believe that they can arrange for a lease financing plan. Assume that the following facts apply:
The equipment falls in the MACRS 3-year class. The applicable MACRS rates are 0.33, 0.45, 0.15 and 0.07.
Estimated maintenance expenses are $75,000 per year
Morris-Myer’s tax rate is 40 percent
If the money is borrowed, the bank loan will be at a rate of 15%, amortized in 4 equal installments to be paid at the end of each year.
The tentative lease terms call for end-of-year payments of $400,000 per year for 4 years.
Under the proposed lease terms, the lessee must pay for insurance, property taxes and maintenance.
Morris-Myers must use the equipment if it is to continue in business, so it wil almost certainly want to acquire the property at the end of the lease. If it does so, then under the lease terms, it can purchase the machinery at fiar market value at the time. The best estimate of this value if $250,000 salvage value, but it would be much higher or lower under certain circumstances.
Explain why Maintenance expenses should be excluded from the analysis (4 marks)
Assuming that the lease can be arranged, should Morris-Myer lease, or should it borrow and buy the equipment? Explain
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