Suppose Procter and Gamble ("P&G") is considering purchasing $15 million in new manufacturing equipment. If it purchases the equipment, it will depreciate it on a straight-line basis over the next five years, after which the equipment will be worthless. It will also be responsible for maintenance expenses of $1 million per year. It can also lease the equipment for $4.2 million per year for the next five years, in which case the lessor will provide necessary maintenance. Assume P&G's tax rate is 35% and its borrowing cost is 7%.
a. Is leasing or owning the preferred alternative? What is the NPV of the favored approach?
b. What is the break-even lease rate? That is, what lease amount (pre-tax) could P&G pay each year and be indifferent between leasing and owning?
This response determines whether or not a company should consider purchasing $15 million new manufacturing equipment or if they should just lease it. NPV and the break-even rate is determined as well.