Case 25 Why Buy It When You Can Lease It? 123 Along with the business, however, Henry inherited some worn-out equipment, which surely had seen better days. Henry was sick and tired of making frequent phone calls to the service company for equipment re- pairs and maintenance work. As a result, service quality was beginning to deteriorate and profits were being hurt. In particular, three ovens, a dishwasher, and a pasta machine needed to be replaced. The total cost of the equipment, including delivery and installation, was estimated to be $100,000. Three-year modified accelerated cost recovery schedule rates could be used to depreciate the equipment. If Papa Trevino were at the helm, there would have been enough cash in the coffer to buy the equipment outright. However, under Henry, the cash balance of the firm had shrunk miserably. The problem with Henry was that, unlike his father, he enjoyed a much more lavish lifestyle. The flashy sports car, penthouse, and boat were all paid in full from business profits, leaving scant cash for business renovation and equipment replace- ment. On numerous occasions, Papa Trevino had tried to counsel his son on the benefits of being thrifty, but to no avail. Young Henry preferred to live for today! Thanks to Papa Trevino's conservative ways, the credit rating of the restaurant had been exemplary. The money for the equipment could be easily borrowed from their bank at a rate of 10% per year over a five-year term. However, Henry had heard from his business colleagues that in some cases it is better to lease than to buy. Many of his colleagues claimed that they were already enjoying significant benefits as a result of having leased business assets. After checking around and calling various leasing companies, Henry found that he could lease the needed equipment and appliances from Quicken Leasing Company for an annual lease payment of $25,000 over a five-year term. The lease would carry an option to buy the equipment for $40,000 at the end of five years. Maintenance costs on the new equipment were estimated to be $2,000 per year and would be covered by the annual lease payment. The increased efficiency of the new equipment was expected to result in net cost savings of $4,000 per year. Henry, being fully aware of his father's dislike for debt, was seriously thinking about leasing the equipment. However, not being fully conversant with all the pros and cons of leasing versus borrowing and buying, Henry needed answers to a number of questions. Above all, he was curious about Quicken Leasing Company's main slogan, which read “Why buy it if you can lease it?" 7. If Quicken Leasing Company's tax rate is 40%, what is the minimum lease payment that it would be Explain. 8. What is the maximum lease payment that Henry should be willing to pay? Explain. willing to accept?