Assume zero taxes. The Black Gold Oil Company can lease equipment at $10,000 per year (first payment 1 year hence) for 10 years or purchased at a cost of $64,177. The company has a weighted average cost ofcapital of 15 percent. A bank has indicated that it would be willing to make the loan of $64,177 at a cost of 10 percent.Questions:1. Should the company buy or lease? There are no uncertainties. The equipment will be used for 10 years. There is zero salvage value.2. If the bank was willing to lend funds at 9 percent, should the company buy or lease?3. If the company pays $64,177 for the equipment, it will save $10,000 a year lease payments for 10 years.4. Comparing "Buy" versus "Lease", what internal rate of return will it earn on its "investment"?5. Now assume a marginal tax rate of 0.4. Assume that the funds can be obtained for 0.10 at a bank. The company uses sum-of-the-years' digits depreciation for taxes. Should the firm buy or lease? (Assume that thepresent value of the depreciation deductions is 0.79997 per dollar of depreciable assets using 0.06 as the discount rate.)

Let's address the questions one by one:

Answered: Assume zero taxes. The Black Gold Oil…

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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.You are negotiating to make a 7-year loan of $25,000 to Breck Inc. To repay you, Breck will pay $2,500 at the end of Year 1, $5,000 at the end of Year 2, and $7,500 at the end of Year 3, plus a fixed but currently unspecified cash flow, X, at the end of each year from Year 4 through Year 7. Breck is essentially riskless, so you are confident the payments will be made. You regard 8% as an appropriate rate of return on a low risk but illiquid 7-year loan. What cash flow must the investment provide at the end of each of the final 4 years, that is, what is X?
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