A firm wants the use of a machine that cost $100,000. If the firm purchases the equipment, it will depreciate the equipment at the rate of $20,000 a year for four years, at which time the equipment will have a residual value of $20,000. Maintenance will be $2,500 a year. The firm could lease the equipment for four years for an annual lease payment of $26,342. Currently, the firm is in the 40 percent income tax bracket.
A. Determine the firm's cash inflows and outflows from purchasing the equipment and from leasing.
B. If the firm uses a 14 percent cost of funds to analyze decisions that involve payments over more than a year, should management lease the equipment or purchase it?
C. Would your answer differ if the cost of funds were 8 percent?
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