United Hospital has received a leasing proposal from Leasing, Inc., for a Siemens cardiac catheterization unit. The terms are:
- Five-year lease
- Annual payments of $200,000 payable one year in advance
- Payment of property tax estimated to be $23,000 annually
- Renewal at end of year 5 at fair market value
Alternatively, United Hospital can buy the catheterization unit for $725,000. This purchase would require United Hospital to debt-finance this equipment. It anticipates a bank loan with an initial down payment of $125,000 and a three-year term loan at 16 percent with equal principal payments. The residual value of the equipment at year 5 is estimated to be $225,000. The lease is treated as an operating lease. Depreciation is calculated on a straight-line basis. Assuming a discount rate of 14 percent, what financing option should United Hospital select? Assume that there is no reimbursement of capital costs.
The solution examines United Hospital leasing proposal from Leasing, Inc. for a Siemens cardiac catheterization unit. The financing options which the United Hospital should selected is given.