Calculate Lease Or Purchase Decision By Company

Question

Suppose Clorox (a multinational manufacturer and marketer of consumer and professional products) can lease a new computer data processing system for $975,000 per year for five years under an operating lease. Alternatively, it can purchase the system for $4.25 million. Assume Clorox has a borrowing cost of 7% and a tax rate of 35%, and the system will be obsolete at the end of five years.

Part A

If Clorox will depreciate (for tax purposes) the computer equipment on a straight-line basis over the next five years, and if the operating lease qualifies as a true tax lease, is it better to finance the purchase of the equipment or to lease it?

Part B

Suppose that if Clorox buys the equipment, it will use accelerated depreciation for tax purposes. Specifically, the CCA rate will be 45% and any undepreciated capital cost (UCC) in year 6 will be taken as a terminal loss. Compare leasing with purchase in this case.

 

Summary

The question belongs to Finance and it discusses about calculating purchase or hire decision by a company given its borrowing cost and tax rate.

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