Chapter 21, Problem 3MC

DECISION TO LEASE OR BUY AT WARF COMPUTERS

Warf Computers has decided to proceed with the manufacture and distribution of the virtual keyboard (VK) the company has developed. To undertake this venture, the company needs to obtain

equipment for the production of the microphone for the keyboard. Because of the required sensitivity of the microphone and its small size, the company needs specialized equipment for production.

Nick Warf, the company president, has found a vendor for the equipment. Clapton Acoustical Equipment has offered to sell Warf Computers the necessary equipment at a price of $3.6 million. Because of the rapid development of new technology, the equipment falls in the three-year MACRS depreciation class. At the end of four years, the market value of the equipment is expected to be $440,000.

Alternatively, the company can lease the equipment from Hendrix Leasing. The leas-e contract calls for four annual payments of $935,000, due at the beginning of the year. Additionally,

Warf Computers must make a security deposit of $210,000 that will be returned when the lease expires. Warf Computers can issue bonds with a yield of 11 percent, and the company has a marginal tax rate of 35 percent.

3. In the leasing discussion, James informs Nick that the contract could include a purchase option for the equipment at the end of the lease. Hendrix Leasing offers three purchase options:

1. a. An option to purchase the equipment at the fair market value.
2. b. An option to purchase the equipment at a fixed price. The price will be negotiated before the lease is signed.
3. c. An option to purchase the equipment at a price of $200,000.