XYZ Storage is evaluating a project which involves producing a new product with an extended marketable life of 4 years.

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XYZ Storage is evaluating a project which involvesproducing a new product with an extended marketable life of 4years. In order to produce this product, the company will have toacquire a piece of new equipment worth $400,000. The company isconsidering whether it should lease or borrow to purchase theequipment. The opportunity cost of borrowing for an asset which hasa purchase price of $400,000 is 15% p.a. Other details of eachalternative are provided as follows:
Purchase:
This equipment can be depreciated at 20% reducing balance ifowned, and has an expected salvage value of $100,000 after 4years.
Lease:
If the lease is in advance, there will be four payments of$145,000 made at the beginning of each year and a residual paymentof $40,000 made at the end of the term, i.e., at the end of year4.
The company tax rate is 25%. Calculate the NPV of leasing andadvise the company as to whether it should purchase or lease theequipment with payments made in advance?
[Total for Question 3: 8 marks]