United Hospital has received a leasing proposal from Leasing, Inc., for a Siemens cardiac catheterization unit. The terms are:
â?¢ Five-year lease
â?¢ Annual payments of $200,000 payable one year in advance
â?¢ Payment of property tax estimated to be $23,000 annually
â?¢ 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.
What financing option should United Hospital select?