Fez Fabulous Fabrics wishes to acquire a $100,000 multifacet cutting machine. The machine is expected to be used for eight years, after which there is a $20,000 expected residual value. If Fez were to finance the cutting machine by signing an eight-year “true” lease contract, annual lease payments of $16,000 would be required, payable in advance. The company could also finance the purchase of the machine with a 12 percent term loan having a payment schedule of the same general configuration as the lease payment schedule. The asset falls in the five-year property class for cost recovery (depreciation) purposes, and the company has a 35 percent tax rate. What is the present value of cash outflows for each of these alternatives, using the after-tax cost of debt as the discount rate?
Which alternative is preferred?